Before the US stock markets opened this morning, the Federal Reserve announced a plan to buy commercial paper directly from issuers in yet another attempt to unfreeze the credit markets. Although this led to a rally in US stocks, USD/JPY and other carry trades, the rally was short-lived. Having been up as much as 165 points intraday, the Dow Jones Industrial Average ended the US trading session down 508 points.

For the Federal Reserve and the US economy, the new commercial paper funding facility is a step in the right direction because it lends directly to business sector. However what the Fed ceases to realize is that the lack of liquidity comes from the lack of confidence and so far, their approaches have been too conservative to warrant a recovery in confidence. We have been calling for coordinated easing by central banks around the world, but the Reserve Bank of Australia has now raised the bar by cutting interest rates 100bp. In response to the turn in equity markets, Fed Chairman Ben Bernanke has finally buckled when he said that the Federal Reserve is ready to cut interest rates. Unfortunately a quarter point rate cut at this point is not enough, especially when compared to Australia’s full percentage point cut. If the Fed had surprised the markets with a 25bp rate cut last week after the House’s approval of the bailout plan, that one-two punch to the credit crisis may have done the trick, but now the Fed needs to do more if they want to put an end to the hemorrhaging that we have seen across the financial markets.

Is the Fed Waiting for the G7 Meeting?

One possible reason why the Federal Reserve has yet to cut interest rates may be because they are saving ammo for Friday’s G7 meeting. According to the comments by ECB member Quaden this morning, the Federal Reserve’s counterparts in Europe are also ready to cut interest rates. As we have seen by the Fed’s commercial paper announcement, the Bank of England’s plan to inject capital into as much as GBP 45B into banks and Spain’s EUR 50B bank rescue fund, fractured responses are not working. A signal of solidarity and coordinated interest rate cuts by central banks around the world is the minimum that the markets need in order to reverse the current trend. US stocks continue to sell off with the Dow Jones Industrial Average falling to the lowest level in 5 years.