The Fed may be done - Get over it

Yes, the central bank delivered another big rate cut. But it may also be getting ready to stop cutting rates so it can fight inflation and the weak dollar.

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By Paul R. La Monica, editor at large


NEW YORK ( -- For the first time since the credit markets began to unravel last summer, the Federal Reserve didn't buckle to Wall Street's demands. It looks like Fed chair Ben Bernanke may be growing into this job.

In the wake of the near collapse of Bear Stearns (BSC, Fortune 500) in the past few days, many were calling for the central bank to slash interest rates by at least a full percentage point on Tuesday.

Instead, the Fed lowered two key short-term rates by three-quarters of a percentage point. But a lot of investors wanted a full point. The fact that the Fed resisted the urge to make a historically large rate cut is a good sign.

Bernanke and the rest of the Fed's policy makers need to be as concerned with keeping inflation in check as preventing a recession - or minimizing the length and severity of a recession if we're already in one.

And even though more rate cuts may finally help get the economy back on track by encouraging banks to lend again, the rate cuts also wreak havoc on the dollar, causing spikes in the prices of oil, gold and other commodities.

With that in mind, one market strategist said the Fed seemed to be sending a statement to investors. It won't let the dollar continue its free fall and will try to put an end to the run-up in commodity prices, a surge that many believe has been fueled by hedge funds and other speculative investors.

"Much more attention was paid to inflation in the Fed's statement than in the past several releases," said Bill Knapp, investment strategist with MainStay Investments, a firm with more than $37 billion in assets under management.

"The Fed would be remiss if it did not acknowledge inflation since it is exacerbated by the rate cuts. The statement seemed like a shot across the bow to energy and commodity speculators. The days may be numbered for speculators," Knapp added.

As such, Knapp said he believes the Fed was probably debating whether or not to cut rates by a half-percentage point or three-quarters of a point and that a full-point cut was not an option on the table.

It's also worth pointing out that there seems to be growing disagreement at the Fed about what to do next, as more members of the central bank's policy-making committee are expressing more concerns about inflation.

Two Fed members voted against the rate cut yesterday. Usually, the Fed votes are unanimous and when there is a dissenting opinion, it's typically only expressed by one member.

One fund manager suggested to me that this might be the Fed's way of telling the market that the rate cuts will soon come to an end.

"The dissenting votes could be a signal to the market that the Fed is done unless another shoe drops in the financial sector," said Frank Ingarra Jr., an assistant portfolio manager with Hennessy Funds.

And there may be something to that notion. In fact, the last time two members of the Fed's Open Market Committee disagreed with the majority opinion was in September 2002. At that time, the Fed decided to keep rates unchanged but two members voted for a rate cut.

Guess what happened at the Fed's next meeting in November 2002? The Fed cut rates by a half-point. So don't be surprised if the inflation hawks on the Fed eventually have their way. I'm not sure the Fed is done lowering rates yet but it's possible the Fed may only cut rates by a half-point or less at its next meeting at the end of April and that this could be the final cut in this easing cycle.

Simply put, the Fed is running out of room to keep aggressively lowering rates. With yesterday's rate cut, the federal funds rate now stands at 2.25%.

At some point, the market needs to recognize that the only thing to be done is to sit back and wait and see if the Fed's rate cuts, combined with its bailout of Bear Stearns and injection of billions of short-term funding for banks, eventually stimulate the economy in the second half of the year.

After all, the first cut in this easing cycle was only six months ago and the Fed just created its so-called term auction facility to lend money to banks in December. It's unreasonable to expect any of these moves to work overnight.

"The Fed signaled with Bear Stearns that it will intervene when there is a dire situation and make sure there is no collapse," said Claire Gruppo co-founder and managing director of Gruppo, Levey & Co. an investment bank with expertise working with distressed companies. "The Fed has taken the steps it needs to take. But whether it's enough or if it's too little or too late are the big question marks."

This may not be what increasingly impatient and short-term focused investors want to hear. But exercising caution instead of making more drastic moves is exactly what the Fed needs to be doing right now.

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