Thursday, January 31, 2008

Late Sell-Off Sinks Stocks

Indexes shot higher after the Fed cut rates one-half percent, only to tumble on fresh worries about bond insurers

Even by the rarefied standards of January 2008 (aka the "January from Hell") Wednesday's stock market was truly weird.

After sustaining modest losses for much of the session as traders paced the floor waiting for the outcome of the Federal Reserve policy meeting, major indexes shot higher in the wake of the central bank's 2:15 pm EDT announcement of a 50 basis point cut in the Fed funds rate target to 3.0%, just eight days after a surprise 75-basis point easing. The Dow Jones industrial average logged triple-digit gains. The market got what it wanted, and the champagne was flowing.

But any good cheer in the markets these days is fleeting, as a number of terrifying beasts lurk in wait for Wall Street. Indexes gave back their gains in the final hour of trading to finish with losses amid fears that U.S. bond insurers Ambac (ABK) and MBIA (MBI) will be downgraded by ratings agencies, after CNBC reported such moves could come as early as Wednesday. And Fitch cut the AAA rating on FGIC's bond insurance arm to AA, saying it does not have the capital needed for a top rating.

The markets are worried that if bond insurers, the primary backstop for credit quality in debt markets, lose their triple-A designations, it could create problems in the broader financial sector.

On Wednesday, the Dow Jones industrial average finished with a loss of 37.47 points, or 0.3%, to 12,442.83. The broader S&P 500 index shed 6.49 points, or 0.48% to 1,355.81. The tech-heavy Nasdaq composite index fell 9.06 points, or 0.38%, to 2,349.00.

The last-hour sell-off was emblematic of the market's volatile January.

The Fed's move Wednesday came just eight days after it cut rates 75 basis points in an effort to boost a flagging U.S. economy and stabilize jittery financial markets.

In its post-meeting statement, policymakers said that "[financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets."

As for inflation, the FOMC expected it to "moderate" in coming quarters, "but it will be necessary to continue to monitor inflation developments carefully."

"Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks."

The Fed's language indicates it is leaving the door open for further rate cuts ahead, according to Action Economics.

There was one FOMC member voting against the easing: Dallas Fed president Richard W. Fisher, who preferred no change in the Federal funds rate target.

"The economy is in or near a recession, so only time will tell if this move is sufficient to avert further economic deterioration," said Kurt Karl, chief U.S. economist for Swiss Re. "Since Fed monetary easing takes about a year to have its full impact on the economy, this will help cushion the growth slowdown but only by late this year and early next year."

"Unless the economic data show enough strength to shift market expectations on rates, we see the Fed cutting the funds rate to 2% at the March 18th FOMC meeting," wrote Bear Stearns economists in a note Wednesday. "The problem with this strategy is that it is likely to boost inflation pressures over the next year," they wrote.

On Wednesday, a report on gross domestic product showed the U.S. economy barely grew in the fourth quarter of 2007. U.S. GDP grew 0.6% last quarter, half the percentage economists were expecting. The advance reading is a big slowdown from the third quarter, when GDP jumped 4.9%.

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