Over the same period, the S P 500 had climbed 10 per cent. Rising stock prices would not have alarmed the Fed, which is concerned about the effect of the fall of prices on consumer confidence. But the action of the bond market may have been a cause for concern. Rates had been rising, and the yield on 10-year government bonds had climbed to 4.84 per cent by yesterday from a low of 4.45 per cent on March 23, shortly after the previous cut. The Fed's ability to affect the economy is based on its control of short-term interest rates.
Lower rates reduce the cost of borrowing and are supposed to stimulate economic activity.
But the only rates it directly controls are the federal funds rate, the rate at which banks lend money to each other, and the discount rate, the rate at which it lends directly to banks. This rate is less important now because few banks borrow directly from the Fed. But the bond market, which had cut rates sharply in late 2000, even before the Fed acted, has remained largely aloof, and yields on Treasury bonds with maturities of more than five years were higher than they had been on January 2, before the Fed's first rate cut. That rate cut aborted a stockmarket plunge, and seemed to some analysts to have been sparked by the market. The Nasdaq leapt a record 14.2 per cent that day, to 2616.69, but later gave back all of those gains as it became clear the economic news was worsening.