Credit worries offset Fed rate cut boost

Worries about further losses for the financial sector got the better of investors on Thursday, putting pressure on stocks and taking the shine off another interest rate cut by the Federal Reserve.

Investors instead sought the safety of government bonds after Fitch Ratings downgraded bond insurer FGIC Corp's credit rating and Standard & Poor's said it has cut or may cut hundreds of billions of dollars of U.S. mortgage-backed securities and collateralized debt obligations.

If bond insurers lose their top "AAA" ratings, U.S. financial institutions will face fresh write-downs of as much as $70 billion, according to Meredith Whitney, banking analyst at brokerage Oppenheimer & Co.

This overshadowed the Fed's move on Wednesday to slash its key fed funds rate by 50 basis points to 3 percent -- the lowest since June 2005 -- following last week's emergency 75 basis point cut to halt a sharp slowdown in an economy struggling with a housing slump and credit crunch.

"There was the knee jerk reaction you'd expect with stock markets rallying, and risky assets rallying and the dollar under pressure," said Martin McMahon, FX strategist at Credit Suisse in Zurich.

"But the U.S. (stock) markets didn't hold on to their gains and a lot of the move reversed. There's some more bad news on monolines which is spooking investor sentiment on the general financial sector."

McMahon added the fact that the Fed cut rates by 125 basis points in nine days was not grounds for optimism, but a sign of a really grim outlook.

The FTSEurofirst 300 index of top European shares slipped 0.8 percent in early trade with London's FTSE also down 0.8 percent and Germany's DAX losing 0.6 percent.

Earlier, Japan's Nikkei managed to squeeze out a 1.9 percent gain despite Wall Street's decline, while MSCI's measure of other Asian stock markets gained 0.8 percent.

MSCI world equity index was ahead by a modest 0.2 percent.

BONDS, DOLLAR FIRMS

Demand for less risky assets helped boost safe-haven government bonds, pushing the March Bund futures up 25 ticks to 116.13. The 10-year Bund yields were down 2.2 basis points at 3.99 percent.

In the currency market, the dollar recovered from an early decline in reaction to the Fed's rate cut, rising 0.3 percent against a basket of major currencies as stocks lost ground.

It was up about 0.3 percent against the Japanese currency at 106.71 yen, while the euro slipped 0.3 percent to $1.4842.

Among commodities, U.S. crude fell nearly $1 towards $91 a barrel on worries that heavier financial losses would drain the U.S. economy and hurt demand at a time when inventories of crude and gasoline are rising quickly.

But metals gained as traders anticipated higher consumption from China, while others such as zinc futures were boosted after China's zinc industry was hit by severe winter weather.

"Shanghai copper is gaining as consumption of the metal usually picks up after the Chinese New Year holidays," said analyst Cai Luoyi at China International Futures, referring to the Lunar New Year holidays beginning next week.

Gold was trading in a slim range around $924 an ounce, taking a breather after rising to an all-time high of $933.10 on Tuesday.

(Published by Reuters, January 31, 2008)