Morning update

Fed meeting on tap

Today's Federal Reserve rate decision at 2:15 p.m. ET has been greatly complicated by the unexpected events that unfolded over the weekend. Prior to Lehman's failure and the threat that AIG may face a similar demise, the Street had widely expected the FOMC to hold rates at 2.0% and issue a statement that saw risks to economic activity rise in light of the worsening employment situation. However, before the latest events that have sent financial markets reeling, inflation risks were likely to get some play given still-high gasoline prices and a core rate that is stubbornly holding above the Fed's implied target of 1-2%.

Most economists surveyed by Bloomberg still see the Fed holding its main rate at 2.0%, but fed funds futures are almost fully pricing in a quarter-point cut to 1.75% in order to mitigate the risks to the economy. Traders will be looking for soothing words from policymakers. But with the Fed encouraging business leaders to come up with a private solution to the crisis, the Street may find little comfort from the press release when it is released later today.

Separately, the Fed said it accepted $50 billion in overnight repos as it attempted to stabilize money markets. The New York Fed said it expects to conduct a large liquidity injection this morning.

After rising 0.8% in July, the Consumer Price Index fell 0.1% in August, matching the Bloomberg estimate. The core rate, which excludes food and energy, was up 0.2%, also in line with expectations. Year-over-year, the headline rate is up 5.5% and core inflation is up 2.5%.

Overseas intervention

European stocks are trading near session lows and are down close to 2% as shares trade at the lowest level since May 2005 amid growing worries that the financial woes in the US could spark a full-blown global credit crisis. Following yesterday's $70 billion injection of liquidity by the Federal Reserve, the European Central Bank added $100 billion, and the Bank of England added $36 billion to ease strains and keep money markets operating smoothly. Meanwhile, Barclays (BCS $21) confirmed it is in talks to buy some of the assets of Lehman Brothers (LEH $0.21). According to the Financial Times, the UK bank is interested in broker-dealer activities, including the equity, M&A and debt, but it is not reportedly looking at Neuberger Berman, which is also part of the bankrupt investment bank.

Losses are not at as bad as yesterday, and shares briefly tried to rally off the bottom after the ZEW survey of German institutional sentiment rebounded from -55.5 in August to -41.1 in September, ahead of the estimate of -53.0. The falling euro, which is expected to help the competitiveness of overseas sales, and falling oil prices supported sentiment. But the extreme uncertainty engulfing financial markets encouraged a new bout of selling, and shares are at the worst levels of the session.

Not surprisingly, financials, which are at the heart of the crisis, are the worst performers on worries about exposures to Lehman Brothers, followed by the mining sector, as falling raw material prices and expectations of weaker economic activity hit the economically-sensitive group. Insurers are also feeling pressure from weakness in Swiss Re (SWCEY $54). The second-largest reinsurer, which is dealing with potential claims from Hurricane Ike, could suffer due to problems faced by AIG. Swiss Re did not comment on its exposure to the US insurer.

Asia rocked by Lehman collapse

Traders across much of Asia came back from a holiday yesterday and had their first chance to react to Lehman's bankruptcy, Bank of America's (BAC $26 ¹) surprise acquisition of Merrill Lynch (MER $17), and the growing troubles at AIG. The Bank of Japan injected 2.5 trillion yen, or about $24 billion, into the financial system, but the Nikkei 225 Index tumbled 5.0% to a three-year low because of fears that troubles in the US are spreading to Japan. Mining shares tumbled 10%, while banking shares ended down a sharp 8%. Aozora Bank (AOZOF $2) and Shinsei Bank (SKLKY $7), which are believed to have the biggest unsecured claims with Lehman Brothers, dropped 16% and were the worst performing banks. Mitsubishi UFJ Financial Group (MTU $7), Japan's largest bank, closed down 8%.

The rest of Asia fared little better, with South Korea falling 6.1%, Hong Kong closing down 5.4%, and China's Shanghai Composite Index finishing off 4.5% following yesterday's surprise rate cut by the central bank. The unexpected easing suggests that monetary authorities are growing increasingly concerned about economic activity.