The US Fed cut the fed funds target rate by 75 bps to 3.5% and slashed the discount rate by the same amount to 4% after a video conference call overnight, a week ahead of the Fed's regular scheduled meeting on January 29-30. The so-called inter-meeting rate cut is the first since September 17, 2001, when the Fed lowered borrowing costs in the aftermath of the 9/11 terrorist attack.

The latest move was clearly aimed at stemming the panic in financial markets which sent global stocks plunging in the past two days. It is also intended to send a strong signal to show that the Fed is not behind the curve. In the statement that accompanied the rate cut, the Fed said that it was concerned about the downside risks to growth as financial markets continued to deteriorate, the housing contraction deepened and labour market softened. The Fed also moved to a more explicit easing bias by saying that "appreciable downside risks to growth remain" and that it would act in a timely manner to address these risks. Investors interpreted this to mean further rate cuts. Interest rate futures market is pricing in a high probability of another 50 bp rate cut at next week's regular FOMC meeting.

The latest inter-meeting rate cut was in sharp contrast to the gradual approach adopted by the Fed. Its urgency reflected the deterioration in economic fundamentals over the past month. With US manufacturing, as reflected by a sub-50 reading in the ISM index, as well as private sector job loss, the US economy lost momentum fast. Other leading indicators, such as a negative yield curve (10yr Treasuries less fed funds), are also flashing recession signals. While President Bush proposed a USD140-150 bn fiscal stimulus package, investors were not convinced it could help revive growth. The loss of confidence triggered a sharp sell off in global stocks and rally in government securities as investors looked for safe havens.

Having shifted its stance to an easing bias, the Fed is likely to keep cutting rates aggressively. We expect the Fed to lower the fed funds rate again at its regular meetings scheduled for January 29-30 and March 18 by 50 bps each, and then again in the next two meetings by 25 bps each to bring the funds rate to 2.0% by the end of June. While these aggressive moves may not be able to prevent the US economy from falling into recession as it takes time for the rate cuts to filter through different sectors, they would at least ensure that any recession would be short-lived. The last recession in 2001, which was triggered by the dot-com bubbles, only lasted eight months after the Fed aggressively cut interest rates from 6.5% to 1.0%.