As was widely expected, the Federal Open Market Committee left the fed-funds rate unchanged today but simultaneously changed its view of the economy to one of which the risks are "weighted mainly toward conditions that may generate economic weakness." The FOMC cited "softening in the growth of aggregate demand" in its decision to change what was formerly known as its policy bias. The central bank said that softening had been "prolonged in large measure by weakness in financial markets and heightened uncertainty related to problems in corporate reporting and governance." But the Fed's action today did little to appease the financial markets, certainly not equities. After trading relatively flat prior to the 2:15 p.m. EDT announcement from the Fed, major proxies rose immediately after the news, then dropped sharply. U.S. Treasuries, conversely, headed in the opposite direction. At day's end, the Dow Jones Industrial Average was down 2.4% to 8482.39, the S&P 500 was lower by 2.4% to 884.21 and the Nasdaq Composite was down 2.9% to 1269.27. As has often been the case of late, the dollar fell in concert with equities, with the Dollar Index settling down 0.37 to 107.24. Amid expectations the Fed will now almost certainly ease at its Sept. 24 FOMC meeting, if not sooner, the price of the benchmark 10-year Treasury note rose 1 2/32 to 102 12/32, its yield falling to 4.08%, its lowest level since December 1964, according to Miller Tabak. The yield on the two-year note, which is most sensitive to the direction of fed funds, fell to 1.97%. The consensus opinion Tuesday morning, confirmed by market reaction, was that the Fed was in a no-win situation given the range of unpalatable options at the committee's disposal, including:
Leave rates unchanged but change the risk assessment statement -- as was the case -- and people would suggest that the Fed should have taken action now, rather than waiting -- as was the case.
Cut rates and many people would worry that the central bank knew "something" was going on in the banking sector or that they were pressured by the White House to act. A rate cut also would have been a confidence-busting admission by Chairman Alan Greenspan that his mainly upbeat congressional testimony last month was wildly off-base.
Do nothing on either rates or the bias and risk being viewed as out of touch.
"Is there any good news here?" wondered Jeffrey Kleintop, chief investment strategist at PNC Advisors in Philadelphia, which has more than $60 billion under management, just prior to the FOMC announcement. "I'm concerned about today and increasingly concerned about tomorrow," noting only about one-third of companies scheduled to sign off on their financials have done so thus far. Nevertheless, Kleintop is hearing anecdotal evidence of "better things in terms of end demand" from companies such as Illinois Tool Works ( ITW), which PNC is long. He expects to raise the equity quotient of PNC's recommended weighting when its investment policy committee meets on Monday. The current recommendation of 65% stocks and 35% bonds for balanced accounts has been in place all year. "We didn't pull back when we should have but we're now looking to get more aggressive," Kleintop said. The strategist's underlying message was that Tuesday's Fed meeting was something of a nonevent, notwithstanding the market's drama and the heavy media coverage (guilty as charged). Indeed, weakness in Dow components such as Boeing ( BA), General Electric ( GE) and United Technologies ( UTX) was due more to concerns about the airline industry than to anything Fed-related.
Good Night, Sweet Prince
"It's irrelevant," Alexandra Lebenthal, president and CEO of Lebenthal & Co., said of the FOMC meeting. "Who would have ever thought a 1.75% rate would be feasible for a day, let alone however many months. It's an extreme time when I don't see interest rates having a whole lot of effect on the economy if people don't want to do anything." Events such as the FOMC meeting and the President's "Economic Summit" in Waco, Texas, aren't meaningful, she said. "Not when you have as many huge horrible crises that have truly made people question everything they've invested in." On a less psychological but related note, Paul McCulley, managing director at bond fund giant Pimco, put forth the "right question" investors should be asking: "Are Fed funds cuts, by themselves, sufficient to break the ongoing debt-deflation meltdown in the corporate sector?" He described the meltdown as a "self-feeding fall in the market value of assets relative to the par value of debt assumed to acquire them." That fall in value "provokes lenders to withdraw wholesale the presumption that debtors are going concerns," he continued, leading them to "demand that their maturing debts be paid, rather than 'rolled-over.'" McCulley's "unambiguous answer" was that lower rates are insufficient to break that cycle, which continues apace. (The full report is available here. ) The point is one that's been somewhat lost in the recent myopia regarding today's Fed gathering: The fed-funds rate has been at a 40-year low since December, and yet spreads between yields of corporate and Treasury bonds have widened dramatically, while capacity utilization remains well below 80%. In other words, a low fed-funds rate hasn't been the cure for what's ailing corporate America, and it was folly to think another 25 or 50 basis points of easing today (or tomorrow) would change that. Even more amazing, 28 months into a severe bear market and 20 months since the Fed began its historic easing campaign, there still are folks out there who think that lower rates will be the salvation for either the stock market and/or the economy. The market's recent rally on "rate-cut hopes" and today's fall on "Fed disappointment" suggests such beliefs die hard -- sometimes very hard.