Fed decision gives markets the jitters

Brian O’Mahony, Business Correspondent,

By late afternoon, the Dow Jones was down less than 1%, but the FTSE 100 caught a serious bout of the jitters and lost close on £24 billion off its total market value of over £1 trillion, a fall of 2.5% on the day.

It shed billions as banks and energy stocks in particular took a hammering, as nervous investors fled to safer environs.

For every one share that rose in Britain yesterday, two fell in value, as nervousness about the US economy undermined investors confidence in the future of share values.

Concern has also arisen that Fed chairman Alan Greenspan has to some extent lost credibility. It is just a month ago since Mr Greenspan said the economic recovery was underway and markets saw it as a cue that the next move in interest rates would be upwards.

More importantly, they saw it as an endorsement of the US recovery, so critical to the global economic outlook. His indication of an easing bias on Tuesday has puzzled markets whose concerns were compounded by the news that second-quarter growth in the US was just 0.3%, well below the annual growth forecast made for the economy at the end of quarter one of close to 6% for the year.

Economist Niall Dunne of Ulster Bank Investment Markets said he was “concerned” by the easing bias indicated by Mr Greenspan.

One of the difficulties facing the markets at this time is that another cut in US interest rates, down at 40-year lows, is unlikely to change sentiment in the US. Rates have been cut 11 times over the past 18 months, as Mr Greenspan tied to keep stock markets from losing any more of their value.

Some commentators see his actions as contradictory. When the Dow was at 6,000, he warned of “irrational exuberance” in the markets. But when he started to slash interest rates, the Dow was over 9,000 in value and is still well above 6,000 in value, due mainly to the fact that interest rates stand at 1.75%.

Austin Hughes, chief economist, IIB Bank said the Fed’s comments on the economy were likely to cause further havoc on stock markets in the coming weeks.

The Fed’s comments that economic risks were now “weighted toward weakness” was not the kind of news calculated to inspire market confidence, according to the economists.

It’s interesting to note that they are now saying that demand weakness began in the spring - before the equity market rout began. It’s also some change from the tone of mid-July, when Greenspan testified on Capitol Hill that he expected gradual economic recovery this year. So the Fed is clearly worried and analysts are puzzled by the shift in sentiment about the economic outlook for the US.

If there is another month of bad data and weak stocks, then the Fed will have to cut rates on September 24, warned Mr Dunne.