Retracted Memos, Canceled Vacations: Fed Cut Shocks (Update1)

By Caroline Salas

Aug. 17 (Bloomberg) -- RBS Greenwich Capital Markets strategist Kenneth Hackel sent a note to investors from his Greenwich, Connecticut, office at 8 a.m. saying he saw ``few signs that the distress has abated'' in risky asset classes.

Less than an hour later, Hackel sent another: ``Fed action wipes out our earlier message.''

The Federal Reserve's 8:15 a.m. announcement that it cut the discount rate today took traders by surprise, sending futures on the Standard & Poor's 500 Index up 3.6 percent in 46 seconds and erasing a 0.4 percent decline. Two-year U.S. Treasury notes fell after the announcement before reversing course as traders tried to figure out the implications of the Fed's move.

``I just had no clue'' it would happen, said Marilyn Cohen, who manages $250 million in fixed-income at Envision Capital Management in Los Angeles. ``It was a great surprise. My question is: Are we all having fun yet?''

The S&P 500 surged as much as 2.8 percent, after tumbling 9.1 percent through yesterday from a July 19 record on concerns losses on mortgages will hurt bank earnings and cause borrowing costs to rise. Yields on three-month bills climbed as much as 23 basis points, or 0.23 percentage point, in the hour and 15 minutes after the Fed announcement, before paring the increase.

``I was thinking about taking one or two days off, but I don't even think I'll do that,'' Cohen said. ``There's much too much volatility. I always bring my laptop with me, but if I am always connected, that's not much of a vacation.''

`Ease the Pain'

The main measure of U.S. stock volatility declined after reaching a four-year high yesterday.

``When I was shaving this morning, the S&P futures were down about a percent -- this turned everything around,'' said Doug Peta, market strategist at J&W Seligman & Co. in New York, which oversees about $20 billion. ``People in the marketplace just want to ease the pain. Trading floors were delighted.''

The Fed said today it is prepared to take action to ``mitigate'' damage to the economy from the subprime-mortgage collapse, which has been roiling global markets for the past two months.

``There was stunned silence,'' said Asif Godall, head of high-yield credit trading at HSBC Holdings Plc in London. ``No one thought they would act quite so quickly.''

The Fed's announcement from Washington cut the rate at which it makes direct loans to banks by 0.5 percentage point to 5.75 percent and dropped language indicating a bias toward fighting inflation.

`Really a Drag'

``I've been in this business a long time and 99 percent of the time it's a lot of fun, but the last couple of months it's been really a drag,'' said E. Craig Coats Jr., co-head of fixed income at Keefe, Bruyette & Woods Inc., who has been in the bond business since 1969.

``It's very, very hard to make money,'' Coats said in an interview from his New York office. ``Your clients are in bad situations and they're unhappy and it's difficult.''

Coats held the same position at Salomon Brothers in the 1980s, when it was the world's biggest bond trader.

High-yield, high-risk bonds lost 3.1 percent in July, their worst monthly performance since 2002 as concerns about subprime mortgages and an onslaught of debt to finance leveraged buyouts drove down prices, according to Merrill Lynch & Co. index data. Junk bonds lost another 0.25 percent in August as of yesterday, heading for three consecutive months of negative returns.

High-yield, or junk, bonds are those rated below Baa3 by Moody's Investors Service and BBB- by S&P.

`The Longest Week'

``The big thing that needed to be addressed was psychology: There's plenty of liquidity, but people just weren't willing to lend money out,'' said Coats. ``I do think we're turning the ship around here. The Fed's in the game and getting serious about helping things and making things work.''

Credit-default swaps on the CDX North America Investment- Grade Index, a benchmark for the cost of protecting investment- grade bonds, dropped as much as 6 basis points to 72 basis points in New York after rising earlier today to 81 basis points, according to Deutsche Bank AG. Credit-default swaps fall as confidence improves.

``You have no idea how good it feels to see a little bit of green,'' said Thomas Garcia, head of trading at Thornburg Investment Management in Santa Fe, New Mexico. ``This has been the longest week since I can remember.''

To contact the reporter on this story: Caroline Salas in New York at