Fed's near-zero target startles markets

Yesterday's news that the US Federal Reserve would cut its target fund rate to between zero and 0.25% rallied US stocks and sent Treasury bill yields to new lows.

The Fed said it would "establish a target range for the federal funds rate of 0 to 0.25%", down from its previous target of 1%. It also said it would continue to buy up agency debt and mortgage-backed securities, and added it might begin purchasing longer-term Treasury securities. "Weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the Fed's open market committee said in a statement.

The Standard & Poor's 500 index was lifted by the news, rising 5.1% to close at 913.18. At 10:00am GMT today, US Treasury bill yields had dropped to new lows across the curve, with the drop particularly steep at the long end: 10-year yields were at 2.239, down from 3.65 a month ago, and 30-year yields hit 2.723 from 4.18 a month ago.

With the promise of continuing buybacks, agency bond yields also fell - Fannie Mae two-year bonds fell to 1.471% from 1.705% yesterday, and Freddie Mac two-year bonds fell to 1.523% from 1.706%.

The currency markets were relatively unaffected, with the euro and sterling both rising slightly against the dollar - the euro was up 2c to $1.404 and sterling rose 2p to $1.55.

Interbank borrowing rates fell around the world, most sharply in the dollar market. Overnight dollar Libor fell to 0.1325% from 0.1594%, and three-month dollar Libor also fell to 1.5775% from 1.8475%. Sterling overnight Libor was unchanged at 2%, but the three-month rate fell to 3.0575% from 3.1075%. And the euro rates fell slightly -down to 2.195% from 2.204% overnight, and from 3.2025% to 3.145% at three months.

The Ted spread, a measure of perceived risk in interbank lending, derived from the difference between the three-month US Treasury yield and the three-month dollar Libor interbank rate, also fell sharply to 1.54 from 1.82 before the cut.

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