is it safe, page-5

Things are getting better

Fed May Avoid Rate Cut as Liquidity Bid Bears Fruit (Update1)

By Craig Torres and Deborah Finestone

Aug. 21 (Bloomberg) -- The Federal Reserve may be able to avoid an emergency reduction in the benchmark interest rate as some of its steps to increase liquidity show signs of success.

``The flight to safety may be diminishing a bit,'' said Holly Liss, a bond saleswoman in Chicago at Citigroup Global Markets Inc. ``We're seeing more calming of the market as T-bill rates come back to normal.''

U.S. Treasury bill yields rose for the first time in six trading days as demand for the safest government debt declined. Fed officials still don't expect to know for days whether their Aug. 17 cut in the discount rate will improve trading in the $1.1 trillion market for asset-backed commercial paper.

Richmond Fed President Jeffrey Lacker, in the first speech by a policy maker since the Fed cut the cost of direct loans from the central bank to 5.75 percent, said decisions need to be guided by the outlook for prices and growth. Market gyrations shouldn't be the sole consideration, he emphasized.

``Financial market volatility, in and of itself, doesn't require a change in the target federal funds rate,'' Lacker said at a luncheon of the Risk Management Association of Charlotte. ``Policy needs to be guided by the outlook for real spending and inflation.''

Lacker added that ``the jury is still out'' on whether the Fed has done enough to relieve overall liquidity constraints in money markets. ``It's too soon to really make a judgment.''

Futures Traders

Investors and economists still bet that Chairman Ben S. Bernanke will have to reduce the benchmark lending rate between banks, now at 5.25 percent, by at least a quarter point on or before the Sept. 18 meeting. Bernanke has taken a restrained approach to the credit crisis, using other policy tools instead of the federal funds rate target.

``They would like to stay out of this and let markets address the problems on their own,'' said Stephen Stanley, chief economist at RBS Greenwich Capital Markets in Greenwich, Connecticut, and a former member of the Richmond Fed staff. ``Recent experience, most notably in 1998, is that the economic impacts of financial turbulence have been briefer and smaller than many projected at the time.''

Senate Banking Committee Chairman Christopher Dodd said Bernanke agreed to use ``all of the tools at his disposal'' to restore stability in markets roiled by the subprime mortgage crisis. He added that he didn't ask Bernanke to cut the federal funds rate and that the Fed chief didn't pledge to do so.

Dodd Nudges Banks

Dodd, a Connecticut Democrat who is seeking his party's presidential nomination, said banks should take advantage of lower borrowing costs at the discount window. He spoke after meeting with Bernanke and U.S. Treasury Secretary Henry Paulson.

Separately, U.S. President George W. Bush, speaking at a two-day summit with North American leaders in Canada, said the financial system has ``enough liquidity'' to readjust risks.

The central bank on Aug. 17 cut the so-called discount rate half a percentage point to 5.75 percent to direct more cash to companies starved for short-term financing while avoiding an emergency reduction in its broader lending-rate target. Fed watchers said it may take days for banks to begin using the facility and making loans to ease up trading in riskier assets.

Treasury bill yields reversed an earlier drop after the New York Fed lowered the fee bond dealers pay to borrow its Treasuries, in a bid to alleviate a shortage in the market for loans backed by the securities.

`Additional Liquidity'

``We are doing it to provide additional liquidity to the Treasury financing market,'' said Andrew Williams, a spokesman for the New York Fed. He said the rate was the lowest in the history of the program, which has existed in its current form since 1999.

The three-month bill yield climbed 0.52 percentage point to 3.61 percent, rising for the first day since Aug. 13. Yields fell 0.66 percentage point yesterday, the most since the stock market crash of October 1987 as money-market funds dumped asset-backed commercial paper for the shortest-maturity government debt.

Delinquencies on loans to borrowers with limited or poor credit histories hit a five-year high in the first quarter, and builders started work on the fewest homes in a decade in July.

``Recent data on actual housing market activity have dampened my optimism'' about a bottoming-out in the industry, Lacker said. Tighter credit conditions ``could further dampen residential investment.''

Consumer spending and business investment should offset real-estate markets, he added. He also noted that labor markets are strong and prospects for income growth are ``pretty good.''

The Federal Open Market Committee said last week that ``the downside risks to growth have increased appreciably,'' reversing its stance Aug. 7 that inflation was the greatest risk.