MarketView for August 9

Summary  

Wow, what a day it was on Wall Street. In over four decades of working with the Street, I have never seen such continued volatility and that includes October, 1987 a time that resulted in the birth of Streetwise, a companion column to MarketView that can be found in papers and on web sites across the country. The market reversed direction six times after a Fed statement that pledged two more years of near-zero interest rates. Bank shares roared back from recent losses as the Street struggled to decipher the Fed's signals on the economy after a dizzying two-week slide.

About 16.4 billion shares traded on the major equity exchanges, a number that was more than twice the 7.75 billion shares changing hands on average this year. The sad news is that the three major equity indexes are still in negative territory for the year, in spite of Tuesday's strong rally. At its session low after the Fed statement, the S&P 500 came within a few points of entering a bear market, meaning a 20 percent decline from its recent closing high set on April 29.

If you are going to ask me for a reasonable explanation for the day's activity, I cannot offer up one, except to say that fear resulted in a variety of knee jerk reactions that were unduly complicated by a variety of computerized trading programs. In other words, irrationality.

Fed Says Rates to Remain Low for Two Years

The Federal Reserve on Tuesday took the unprecedented step of promising to keep interest rates near zero for at least two more years and said it would consider further steps to help growth, sparking a rebound in stocks. At the same time, the Fed painted a rather bleak picture, stating that economic growth was proving considerably weaker than expected, inflation should remain contained for the foreseeable and unemployment, currently at 9.1 percent, would come down only gradually.

"The committee currently anticipates that economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013," the Fed said. It also reiterated its policy of reinvesting the proceeds from bonds maturing in its portfolio, though it did not state a specific timeframe for such actions.

Nonetheless, an unusually divided central bank pledged to hold benchmark rates at rock-bottom lows until mid-2013, and opened the door to other tools to support growth. The announcement demonstrated just how long the central bank expects it will take before a flagging economy can gather significant momentum.

The Fed said that three policymakers dissented, the biggest such rebellion since 1992, pointing to unusual uncertainty about the outlook and reticence within the Fed about the effectiveness of unconventional policy. Dissenting against the decision was Richard Fisher of the Dallas Fed, Narayana Kocherlakota of Minneapolis and Charles Plosser of Philadelphia, who of whom wanted to avoid any specific time reference on the low-rates pledge.

Wall Street, which was hoping for some news that it could rally around after the past eight days sent $3.8 trillion of paper assets into Never Never Land, did not take the news kindly. Share prices sank and then see-sawed wildly before a strong rally ended the trading day. Treasury yields fell with the 2-year note falling to a record low of 0.1647 percent and the dollar tanked.

Unfortunately, there remains considerable doubt over how long the rally might last given the weak outlook. In a Reuters poll of primary dealers who trade directly with Fed, an increased number said they expected that the central bank will have to fire off another gun before long -- buying bonds to lower rates even further, known as quantitative easing.

The poll found that 37.5 percent now see the Fed resuming bond-buying within the next six months, compared with 27.5 percent who had expected more QE within two years when they were polled last Friday.

However, there still is plenty of doubt regarding the Fed's power to stimulate the economy with rates already so low. Japan provides a disheartening example of a country that has kept borrowing costs low for many years without any notable spike in growth.

Wall Street will now be looking to Fed Chairman Ben Bernanke's yearly speech at the upcoming Jackson Hole meeting to try and discern additional clues into any additional policy easing the Fed might consider at its next policy meeting in September.

The Fed's decision comes amid financial market turmoil as worries about the global economy escalate after an embarrassing downgrade of U.S. debt. In addition, fears remain that European efforts to put a safety net under heavily indebted Italy and Spain may not suffice to avert wider credit market disruptions.

In an attempt to tamp down market volatility, finance ministers and central bankers of the Group of Seven major world economies held a telephone conference on Sunday and then issued a statement saying they were ready to act to ensure global stability.

Officials had been pinning hopes for an acceleration of U.S. growth in the second half of the year on a healing of supply chain disruptions from Japan's natural disasters, a calming of Europe's debt problems as governments committed to more sustainable fiscal paths and steady gains in business and consumer confidence in the United States.

But those expectations, along with the Fed's forecast for a growth rate of between 2.7 percent and 2.9 percent in 2011, have appeared increasingly over-optimistic in recent weeks.