Beige Book Gives Market the Blues

Wall Street had a toxic reaction to news that poisons in the manufacturing sector are leaking into other areas of the economy.

The beige book , an anecdotal survey of businesses, economists and market experts compiled by the Federal Reserve , revealed economic activity was listless in June and July. Worse still, the report showed the downturn -- which many economists thought was contained in manufacturing -- has oozed into other areas.

"Sustained weakness in the manufacturing sector spilled over to other businesses, with many Districts indicating declines in demand for office space and trucking and shipping services," the Fed said.

Shortly after the report was released, the major averages took a dive. For the day, the Dow Jones Industrial Average lost 165.24 points, or 1.6%, to 10,293.50, while the Nasdaq Composite fell 61.4 points, or 3%, to 1966.3. The S&P 500 shed 20.9 points, or 1.73%, to 1183.53.

"The service sector has been carrying the economy along," said Christopher Low, chief economist at First Tennessee Capital Markets. "That weakness has spilled over to other areas of the economy raises a red flag that we may be headed toward a recession."

The report also said that financial institutions across the country have seen reduced demand for loans. "Overall, districts characterized financial markets as cautious, with both borrowers and lenders pulling back in response to economic uncertainty," the Fed said.

According to the St. Louis Fed loan statistics, commercial borrowing has declined at a 20% annual rate. "This is the kind of decline you see going into a recession," Low said.

The report showed that retail sales were weak in June and July. "The weakness in retail sales was broad-based across product lines and types of outlets," the Fed said. Of further concern, orders for back-to-school and Christmas merchandise were running lower than last year in anticipation of slower sales.

The sour news on the economy sweetened the day for the Treasury market. After an initially lackluster day for fixed-income securities, the trading session gained some oomph. It was helped also by good results from the Treasury's sale of $11 billion in 10-year notes at 1 p.m. ET.

The 30-year bond jumped 30/32 to 97 23/32, pushing its yield down to 5.533%.

The Federal Open Market Committee will use the beige book when it next meets to set interest rates on Aug. 21. Currently, fed funds futures , a good proxy for monetary policy, are pricing in 100% odds of a 25 basis-point cut at the Fed's next meeting.

"Today's report gives the Fed the green light to cut," said Low. "And they might not be finished in August."

>To order reprints of this article, click here: Reprints