Financial markets got the half-point interest rate cut they were looking for Wednesday, and nothing more.
The widely expected move by Federal Reserve policymakers to cut the federal funds rate to 5.5 percent failed to inspire the stock market, and major indexes slid after the early afternoon announcement.
The Dow Jones industrial average–which rallied nearly 300 points after the surprise half-point cut in early January–gave away most of its early advance Wednesday, closing with a scant gain of 6.16 points, to 10,887.36.
More telling: The Nasdaq composite index, which recorded its biggest daily gain after the last cut, turned a morning gain into a loss, falling 65.62 points, or 2.3 percent, to 2772.73.
Nonetheless, market observers were optimistic because poor economic reports failed to inspire a wider sell-off and because the Fed’s expressed concern about further economic weakness raised expectations for more cuts in the future.
“I think there’s an increased chance of another intrameeting move if we continue to see scary economic data. The manufacturing sector is weak, no question,” said Jay Mueller, chief economist with Strong Investments Inc. in Milwaukee.
A Reuters poll released Wednesday suggested a growing number of top Wall Street firms expect the Federal Reserve to weigh in with another aggressive interest rate cut by March. Policymakers are scheduled to meet again March 20.
The big question for investors moving forward seems to be centering on where the market’s strength will be in the coming months. The Fed can cut rates only so far before real economic strength needs to start showing up, economists said.
“In the long term, market moves are driven by the profit outlook, simple as that. … Now that they’ve cut [rates], I think that improves the profit outlook,” said Marci Rossell, corporate economist and investment spokeswoman with Oppenheimer Funds.
Others agreed.
“The market has been astonishingly resilient, given the weak economic statistics,” said John Forelli, a portfolio manager with an affiliate of John Hancock Financial Services. After seeing the language in the Fed’s announcement, Forelli said he is more confident that policymakers will cut rates by at least another 1.5 percentage points by June, and that an economic recovery is in the works.
“Right now, we’ve got a tug-of-war between bad news and the longer-term outlook. The market waffled early today, but I think we’ll see growing confidence that any slowdown will be short-lived.”
Investors apparently agree. Despite a string of reports–each seemingly weaker than its predecessor–pointing to a slowdown, the Nasdaq bounced back from last year’s harrowing 39 percent loss with a 12.2 percent gain in January, its fifth-best January ever.
Mueller, however, cautioned against too much optimism.
“Right now we’re skating along the knife’s edge of recession. It’s still an open question,” he said. On the plus side, he said, the housing market seems to be holding up well, and that should continue with interest rates going down again.
Mueller said he’s looking toward corporate earnings to signal the path from here.
“Rates matter, but they’re only part of the story. The real story is the outlook for the economy, and we’re going to have to see earnings growth to move up from here,” he said.
Investors may be willing to tread water for the next few months, said Forelli, but then the impact of the rate cuts will have to start taking effect and helping profits, or the markets are in for some ugly days.
In the futures markets, traders are now keenly focused on President Bush’s tax-cut plan, said Jack Bouroudjian of Commerz Futures in Chicago. “Traders are looking for at least another quarter-point in March, but it’s going to take more than that. Traders want a concrete tax-cut package,” he said.
Bond markets also moved higher Wednesday.
“Treasury futures are factoring in about a 20 percent chance of another 25 basis-point cut before the next [Fed] meeting,” said John Miller of Nuveen Investments in Chicago. Bond market observers, like those in the stock market, are trying to discern the Fed’s strategy, pulling between keeping some powder dry and moving swiftly to reassure the markets, he said.
Wednesday’s move was clearly expected. So expected, in fact, that the Washington Post’s Web site put up a story announcing the half-point increase a few minutes before it was actually announced.
One bond futures trader in Chicago said the news reached the markets before the Fed’s announcement, but there was little reaction, because the news was expected.
Spokesmen for both the newspaper and the Federal Reserve said the newspaper company contacted the Fed about the error and explained that it had mistakenly posted a story prepared in advance of the expected news.
There’s much less consensus about what happens next, of course.
“The market is probably fairly valued at this point,” said Bruce Weininger of Deloitte & Touche in Chicago, adding that corporate profits will soon begin to point the market in its next direction. “The lesson is to not always look backward. Just because something worked last year doesn’t mean it will hold” in a choppy market, he said.
