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News
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The Fed dilemma
A cut could have done more harm than good, say some economists. So why are stock traders so unhappy?
August 13, 2002: 5:01 PM EDT
By Justin Lahart, CNN/Money Staff Writer

NEW YORK (CNN/Money) - Alan Greenspan can't win.

The Federal Reserve's decision to not cut interest rates Tuesday was what most economists expected, but it wasn't, apparently, what the market wanted. After waffling briefly after the Fed announcement, stocks shifted into the red. Prior to the announcement, they had been mildly positive.

"The guys who made the big bets the Fed would cut today were absolutely wrong," said Jack Baker, head of equities at Putnam Lovell.

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By the closing bell, the Dow had shed 206 points. The Nasdaq dropped 2.9 percent.

The stock answer to why the market dropped is that everybody had wanted the Fed to cut. But the funny thing, said Arnold & S. Bleichroeder economist James Padinha, was that ahead of meeting a lot of people were talking about how the best possible thing for the Fed to do would be leave rates unchanged and, in a shift of their policy bias, say the risks to the economy were pointed toward weakness.

It's unclear if the market -- a bit of a drama queen these days -- would have been satisfied with anything the Fed decided. Given the relatively upbeat assessment of the economy Fed Chairman Greenspan offered before Congress just last month, an interest rate cut could have been a huge blow to market confidence.

"Questions would arise over why the Fed needed to drop interest rates at this time," said Morgan Stanley economist Bill Sullivan. "It would have raised fears that there was a train wreck coming in the financial system."

Padinha thinks that's a load of bunk. "You think that if the Fed cut by a half point and left the risk statement unchanged the Dow wouldn't be up 400 points," he said. "Is this a joke?"

In normal times, the market's reaction is of only slight interest to the Fed: Traders may do what they do, but the Fed's job is to manage the economy. These days, however, the dynamic is different. It's apparent that the deterioration in the stock market in June and July prompted fresh caution at U.S. companies.

"The softening in the growth of aggregate demand that emerged this spring has been prolonged in large measure by weakness in financial markets and heightened uncertainty related to problems in corporate reporting and governance," said the Fed in the statement that it released following Tuesday's meeting.

Early evidence from this month show that confidence hasn't improved, said Salomon economist Steven Wieting, and that consumers are flagging. He expects the Fed to cut rates within the next two months and that the only way a cut won't happen is if companies improve their outlook. It's hard to imagine companies' outlook improving, however, if stocks remain weak.

The Fed cleared the way toward cutting rates in its statement when it changed its policy directive, saying the risks to the economy "are weighted mainly toward conditions that may generate economic weakness."

But whether a Fed cut in the months ahead can cure the economy is a matter of debate. If investors and businesses don't believe that lower rates can restore the economy, much of the Fed's power is taken away.

"In many respects, the Fed is a bit player when it comes to the overall outlook," said Sullivan. "We're dealing with issues of confidence."

Unfortunately, confidence can't have got any better after Tuesday's session. A likely headline in Wednesday's papers: "Dow Falls Over 200 Points on Fed Disappointment." Mr. Greenspan, you have a problem.  Top of page




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.