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HOW EFFECTIVE HAS THE FEDERAL RESERVE'S DECISION to hold its balance sheet steady been so far?
Well, consider that the U.S. stock market lost about $400 billion in value during Wednesday's session—about twice as much as the amount of Treasuries the central bank plans to purchase with the proceeds from maturing agency and agency mortgage securities on its balance sheet through 2011.
And the equity declines continued in after-hours trading. Cisco (CSCO) plunged some 8% following management's downbeat outlook on top of a 2.5% decline during regular hours, which was less severe than the Nasdaq Composite's 3% loss. The rout in the chip stocks also extended into the after-hours Wednesday with the Semiconductor HOLDRS exchange-traded fund (SMH) down another 2% after having been crushed by nearly 5% in the two previous regular sessions.
It would seem the problem wasn't what the Fed did, but what it said. But all Bernanke & Co. uttered was what any sentient (and honest) observer knew already: "the pace of the economic recovery is likely to be more modest in the near term than had been anticipated."
And, as noted here ("The Fed's Roll Over—Not Much of a Trick," Aug. 11), the Federal Open Market Committee merely acted to prevent a passive tightening of monetary policy that would be caused by redeeming maturing securities, which would shrink its balance sheet and drain liquidity from the financial system.
The action in the markets around the globe suggested that the Fed took a necessary—but far from sufficient—step in countering the slowdown now evident to the central bank as well as Cisco chief executive John Chambers, who offered disappointing guidance on the company's earnings conference call.
While talk that personal computer orders are "falling off a cliff" rippled throughout the PC supply chain, as indicated by the crunch in the chips stocks, the debacle was not confined to the equity market.
The glass-half-full crowd spoke of a rally in the greenback as the Dollar Index jumped 1.9% in its best gain of the year. But the real story was a plunge in the euro nearly as steep as the Nasdaq, dropping more than "three big figures" in forex trader talk, to under $1.29 Wednesday from $1.32 Tuesday afternoon.
In a reminder that the European sovereign debt crisis has merely subsided temporarily, the euro plunged after the spread between Irish and German 10-year bonds blew out after European Union approved an additional €10 billion in aid for nationalized Anglo Irish Bank. Meanwhile, the bund yield fell to a record low of 2.46%.
In terms of records, the U.S. Treasury auctioned 10-year notes with a new low coupon rate of 2 5/8%, although the auction yield of 2.73% was higher than the record low of 2.419% in January 2009 near the nadir of the credit crisis. The new benchmark issue's yield got down to 2.70% in late trading Wednesday, a 16-month low.
The risk aversion also extended to the Japanese market, where the 10-year bond yield dipped back below 1% on reports of Chinese official buying on the perception that JGBs were safer than Treasuries because almost all Japanese debt was domestically owned. Whatever the reason, strong demand lifted the Japanese currency to a 15-year high as the dollar fetched less than 85 yen.
Meantime, China showed further signs of slowing growth, which added to market jitters even though that was precisely the goal of Chinese authorities. Still, slowing growth in China exacerbated pressures on already reeling U.S. industrials, which joined techs and financials in leading Wednesday's retreat.
Taking a step back from Wednesday's price action, it's apparent now to even a casual chart watcher that the July rally in the S&P 500 essentially was a 50% retracement of its fall from the April peak around 1212 to its mid-year low of 1022, back to around 1125 at the beginning of August. Wednesday's rout sent the S&P through its 200-day moving average, the 1100 round number and left it sitting right on its 50-day at the official close in New York.
The resumption of the decline from the April highs should show that the Fed cannot fix all of the economy's problems. Yet, if it were intent upon doing something to juice the flagging recovery, the calendar dictated the Federal Open Market to take this first, small step toward quantitative easing at Tuesday's meeting.
Most likely, the FOMC will want to stand pat at the next meeting on Sept. 21 as the political season heads into high gear. The following meeting is scheduled to begin on Tuesday, Nov. 2—Election Day—and end the day after the votes are counted. By waiting until then to take more dramatic action in the form of further outright quantitative easing—QE2—the Fed can dodge accusations of influencing (or being influenced) by the mid-term elections.
That is, if Bernanke & Co. can avoid being forced by events to act earlier. As usual, 'tis the season for market crises in September and October.
Comments? E-mail us at online.editors@barrons.com
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