'Downside Risks to Growth Remain': Fed Cuts Rates to 1%, Might Not Be Done

Updated from 2:55 p.m. EDT 

As was widely expected, the Fed cut the fed funds rate by 50 basis points to 1% Wednesday, matching a half-century low. As is typical, the stock market had a fitful reaction to the Fed's move.

Update: After moving in a narrow range prior to the Fed's 2:15 p.m. announcement, the Dow experienced a nearly 500-point swing in the final 90 minutes of trading. After peaking at 9362, the index swooned to close down 0.8% at 8991. The S&P fell 1.1%, hurt by weakness in General Electric, financials like Wells Fargo, and big-cap tech like Google and Intel. Still, the Nasdaq managed a gain of 0.5% behind strength in Apple and Research In Motion. 

This latest bit of intraday volatility came as GE gave cautious comments about 2009 earnings and market players combed through the statement accompanying the Fed's latest move.

"The pace of economic activity appears to have slowed markedly," the Fed declared. While not a surprise to most Americans, that's pretty straightforward language from the central bank, which probably had a sneak-peek at tomorrow's GDP report.

"The new language is tantamount to the FOMC acknowledging a recession with scant prospects for a near-term recovery without actually employing those words," writes Michael Darda, chief economist of MKM Partners.

The Fed went to on say: "Recent policy actions, including today's rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain." (Italics added.)

Citing declining commodity prices and weak economic activity generally, "the Committee expects inflation to moderate in coming quarters."

That's Fed-speak for: "we're no longer worried about inflation."

So if the Fed thinks inflation is no longer a problem and downside risks remain, Ben Bernanke might  "better" his mentor Alan Greenspan and ultimately take the funds rate below 1%. (Update: Fed fund futures are now pricing in 100% odds of at least another 25 basis point rate cut before year-end.)

One other line in the statement raised the eyebrows of some Fed watchers: "slowing economic activity in many foreign economies is damping the prospects for U.S. exports." (Italics added)

In other words, the Fed wants to see the dollar weaken and is intent on pursuing the "pro"-inflationary policies Henry and I discussed this morning.

Notably, the dollar weakened and precious metals rallied in the immediate reaction to the Fed's announcement.

Update: This kind of "reflation trade" is precisely what the Fed was hoping for but the stock market's inability to build on Tuesday's monster advance is a fly in the ointment. Once again, optimism was thwarted and the wild swings left even seasoned pros agog.

But many traders are still expecting near-term gains; bulls are betting on a push from money managers suffering from "performance anxiety," i.e. when fear of missing a rally outweighs fear of another big decline.