New York Market: Dow Jones - Hopes for rate cut wane

OPTIMISM for an imminent interest rate cut is waning after Federal Reserve Chairman Alan Greenspan suggested that the paralysis that gripped financial markets since August has begun to relax.

Yet some of the biggest bond investors say conditions in the credit markets are far from normal, and that they still expect the Fed to cut rates, for a third time in less than two months, when policy makers meet on 17 November.

"A quarter of a point is a small price to pay for insurance; from there on, they'll have to reassess the situation," said William Gross, bond manager at Pacific Investment Management. "What's the risk of not doing it? Setting off another round of contagion."

When Mr Greenspan ordered the 15 October rate cut - the first change between meetings in more than four years - a central bank statement said it was intended to curb the "growing caution by lenders and unsettled conditions in financial markets".

Since the last cut, Fed officials have said publicly that they're keeping a close watch on US credit market conditions to make sure they settle down. While there's been improvement, anomalies still exist.

"Conditions have not come back to what one would describe as normal," said Jonathan Francis, head of global strategy at Putnam Investments. Corporate bond sales, which ground to a halt between early August and mid-October, have picked up again. Yet traders say it's still tough to trade all but bonds of the biggest companies because securities firms, stung from recent trading losses, are reluctant to make markets in many bonds.

While the Fed might not follow up a November cut with further moves this year, Mr Gross predicts the Fed will eventually cut rates to 4 per cent as the economy slows.

Others argue it would be hard for Fed officials to make a case for easing based on the economy. The Fed's own forecasts show growth slowing to 2 per cent to 2.5 per cent next year - a level long considered the fastest rate the economy can grow without raising the danger of accelerating inflation.

At the same time, some analysts now say the worst may be over. A 13 per cent gain in the Dow Jones index since 13 October may pave the way for a pick-up in consumer confidence after it dropped to its lowest level in almost two years. Copyright: IOS & Bloomberg