MarketView for September 23

Summary  

The major equity indexes ended the day on Friday in positive territory, a welcome relief from the negative days of late. The primary trigger for the rebound came from policymakers suggesting additional steps will be taken to support Europe's financial system. Nonetheless, the Dow Jones industrial average still suffered through its worst week since the depths of the financial crisis in 2008, the result of anxiety over Europe's spiraling debt crisis and a warning from the Federal Reserved about tour domestic economy.

Stocks seesawed between gains and losses on Friday, but the S&P was able to hold above the August 8 low of 1,119, a key support level that served as a trigger for buyers during the week. Yet, for the week the Dow was down 6.4 percent for its worst weekly performance since October 2008 and the Nasdaq lost almost 5.3 percent.

While the market remains susceptible to further losses, many traders believe it will take a significant deterioration, either in the economy or in Europe, to spur another sharp decline. Nonetheless, volatility was higher, in large part because of the seemingly never ending fears of a Greek default and the Federal Reserve's gloomy prognosis for the economy that resulted in heavy equity selling. The CBOE Volatility index chalked up a gain of 0.6 percent, making the rise its fifth straight advance. Trading was active with about 8.9 billion shares changing hands, a number that was well above the daily average of 7.94 billion shares.

The escalating turmoil in global markets has led many on Wall Street to cut their year-end targets for the benchmark S&P 500 index, with even some of the most bullish investors beginning to scale back their optimism a bit.

Gains in the Nasdaq were helped by semiconductor stocks. Texas Instruments gained 3.8 percent to close at $27.22. Hewlett-Packard Co was down 2.1 percent to $22.32 a day after Meg Whitman, the former head of EBay, was named to run the company. The move was met with criticism of the company's board, which has been accused of recent missteps.

Fed Opinions Come Out

New York Federal Reserve Bank President William Dudley said on Friday that the build-up of debt before the 2007-2009 financial crisis, and the crisis itself, created an 'unusually anemic recovery' that has overwhelmed policymaker efforts to stimulate demand with monetary and fiscal easing.

Regulators have made a "good start" on boosting capital requirements and creating other rules to rein in the kind of risk-taking that fueled the recent boom and bust, Dudley said.

"The extraordinarily poor economic outcomes we see today underscore the importance of building a financial system that is resilient in its ability to provide credit to households and business throughout the business cycle," Dudley said.

Monetary policy is too blunt a tool to stop booms, he said, and while regulators may try, they will be unable to head them off without a profound overhaul of the financial system. Banks are better capitalized than they were at the depths of the crisis, he said, but while progress to boost liquidity has not gone as far as needed, he said.

Meanwhile, John William, president of the San Francisco Federal Reserve Bank indcated that unconventional monetary policy tools like large-scale bond purchases can effectively lower long-term borrowing costs, but the effect on the real economy is less clear.

According to Williams, "Specifically, does lowering Treasury yields through large-scale asset purchases have the same effect on the economy as an equivalent movement in the federal funds rate? To what extent is it the size or the composition of the central bank's balance sheet that matters?"

The answers to those questions require further study, he said, without tipping his hat as to his view on the subject. The question of the effectiveness of unconventional monetary policy tools is critical to the U.S. central bank, which has increasingly relied on such tools to try to kick start a recovery from the worst recession in decades.

After cutting short-term interest rates to near zero in December 2008, the Fed turned to large-scale asset purchases, buying a total of $2.3 trillion in long-term securities through June of this year. Those programs, along with the Fed's pledge to keep rates low for an extended period, were effective in reducing both short-term and long-term borrowing costs, Williams said.

But the exact effect on the economy is less clear, he said.

Dogged by a persistently high unemployment rate that stood in August at 9.1 percent, the Fed last month said the economy was so weak it was likely to need the support offered by near-zero short-term rates until at least mid-2013.

This week the Fed went a step further, embarking on a new $400 billion program to weight its $2.85 trillion balance sheet more heavily toward longer-term securities.

Williams, who is not a voter this year on the Fed's policy-setting panel, did not say whether he supported the move.