Don't Blame the Fed for Selloff

NEW YORK (TheStreet) -- Did the economic mess force the Federal Reserve's hands just as a debt mess forced Standard & Poor's? Equity markets certainly seem to think so.

The central bank made do with its limited options by announcing "Operation Twist" Wednesday. Back in August, the ratings agency also faced little choice but to follow through on a downgrade of U.S. government debt amid the political gridlock over the deficit. Both moves were widely anticipated, although neither came without controversy. In reaction, stocks have thrown a tantrum.

Thursday's trading was an unfortunate reminder of the global selloff last month. On Aug. 8, the first session after news of the downgrade, the blue chips plummeted 5.5%. This time around, the sum of losses from late yesterday following the Fed statement and today's 391-point drop amount to a near 6% plunge.

But critics would be wrong to use today's global selloff as an argument that the Fed misstepped, just as it would have been unfair to call out the ratings agency. The Fed and Standard & Poor's acted appropriately given their respective mandates -- the Fed's being to target inflation and unemployment using monetary tools and the S&P's being to publish an accurate assessment of credit worthiness.

The Fed's description of the economic outlook facing "significant downside risks" may have deepened investor worries, yet had the bank been optimistic, it would have been accused of trying to inspire false confidence. In short, both the Fed and S&P had to be harbingers of bad news whether they wanted to be or not.

A number of other factors of course worsened today's selloff, including disappointing Chinese manufacturing data that hit Asian markets overnight and dreary business data from the eurozone. Furthermore, today's macroeconomic backdrop is significantly worse than it was in early August -- Greece is closer to a collapse, and Europe's financial system teeters on the edge of buckling.

"The timing for a selloff is incredibly difficult to predict," says Francisco Torralba, economist with Morningstar Investment Management. "One big trade triggers other people to trade as well. ... It all comes down to sentiment."

Investors were spooked today, although persistent volatility has numbed investors to surprises in the marketplace. The most important takeaway is that causes for blame lie outside the scope of the Fed, with fingers pointing increasingly, and correctly so, to the lack of proper fiscal leadership.

-- Written by Chao Deng in New York.

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