Federal Reserve does nothing and the markets aren’t happy

I guess financial markets were looking for the Federal Reserve to dump billions into bonds and stocks today.

At least that’s what I conclude from the drop in stock prices this afternoon after the Federal Reserve’s Open Market Committee gave no indication that it was about to open the floodgates.

I don’t think the markets had any reason to believe that the Fed would decide to unleash a wave of bond buying on the markets. But the lack of a reason has never stopped markets from dreaming. And right now most investors—I know I feel this—would like someone to do something to stop the pain.

The statement from the Open Market Committee actually sounded relatively optimistic. (Granted that when most voices are calling for the end of the world, it doesn’t take much to sound optimistic.) “Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth,” the Fed said. “The Committee continues to expect a moderate pace of economic growth over coming quarters”

Given that view, the Federal Reserve decided to stay on the current course. The Fed will continue its current policy of buying longer maturity Treasuries when short-term Treasuries in its portfolio mature. Read more

Stocks soar as world’s central banks move to support big banks just hours after S&P downgraded them

Put that in your new ratings model and smoke it, Standard & Poor’s.

Hours after Standard & Poor’s downgraded 16 of the world’s biggest banks—largely because the company’s new model for awarding credit ratings decided that governments were less likely to support their big banks—six of the world’s central banks, led by the U.S. Federal Reserve, came to the support of the world’s big banks.

In a coordinated move the central banks lowered the cost of emergency dollar funding by 0.5 percentage points. By lowering the cost of dollar funding from the central banks, the move will make it easier for stressed European banks to fund their dollar-denominated activities. The cost to European banks to fund in dollars had climbed to the highest level in three years.

On the news of the central bank move, the German DAX Index was up 4.9%, and the U.S. Dow Industrial Average had climbed by 3.7% and the Standard & Poor’s 500 by 3.6% as of 11:45 a.m. New York time.

Shares of the banks that S&P downgraded yesterday are performing even better. Read more

Lack of inflation in October leaves Fed free to act

Consumer inflation declined in the United States in October by 0.1%. That was the first drop since June. The core inflation number, which excludes food and energy, climbed 0.1% in October.

I wouldn’t make too much of this number—for reasons that I’ll explain later—but it is good news. A decline in inflation, for whatever reason, gives consumers a bit more spending power going into the holiday shopping season.

The absence of inflation also means that the Federal Reserve can concentrate on stimulating the economy—QE3 anyone?–without the constraints imposed by worries about letting inflation get out of control. And there’s certainly nothing in these numbers to endanger the Fed’s pledge to keep its benchmark interest rate near 0% until mid 2013.

You don’t have to look far for the reason for the October drop in inflation. Energy prices fell 2% in October from September. That’s largely an artifact of the way that the Bureau of Labor Statistics conducts its price surveys. The government statisticians examine consumer prices during a single week in the month. In September that week happened to correspond to a small surge in gas prices—the major reason that inflation rose by 0.3% in September from August. In October the sample week saw prices considerably lower than those in that week in September.

I don’t think, therefore, that you can use the October drop to conclude that inflation is falling in the long run. But I think it is safe to say that inflation isn’t about to run out of control—and that deflation isn’t a danger either at the moment.

What’s called headline inflation climbed by 3.5% from October 2010. But core inflation, the number the Federal Reserve watches, rose at just a 2.1% rate from October 2010. The Fed’s inflation target is 2% or less.

Virtually unnoticed amidst all the sturm and Draghi last week from Europe, on Wednesday November 2 the U.S. Federal Reserve inched closer to a new program of quantitative easing. The likely shape of a QE3 would reflect the Fed’s fears that U.S. economic growth is still way too weak and fragile, that the big problem is a lack of any real recovery in the housing market, and the failure of “Operation Twist” to significantly lower mortgage rates.

What would move the Fed to actually pull the trigger on a program that would result in a political fire storm—remember Republican president nominee Rick Perry has already said he’d regard Fed Chairman Ben Bernanke as a traitor if the Fed tried to increase U.S. economic growth ahead of the 2012 Presidential election?

Two things, I think: Read more

New fear on old news is driving today’s drop

So what’s new this morning? What’s new today that has ratcheted fear up another level?

The Standard & Poor’s 500 stock index is down another 2.78% as of 11:30 a.m New York time this morning. That, on top of the 2.9% drop yesterday, brings the four-day pummeling to 6.5%. The MSCI All-Country World Index has moved into bear territory—it’s now down 22% from the May peak.

Most of what is moving the market this morning—and the day before and the day before that—is actually new fear on old news.

Yes, in yesterday’s announcement the Federal Reserve’s Open Market Committee stressed that it saw “significant downside risk” in the U.S. economy. But, gosh, didn’t we know that?

Three Italian banks were downgraded by S&P today. Following on the downgrade of all of Italy on Tuesday, this is surprising?

Yesterday Moody’s, which is playing a competitive game of “Can you match my downgrades?” with S&P cut the ratings on Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC). Not good news, I grant you, but again nothing you didn’t know if you’ve been following the headlines of the bad mortgage problems at Bank of America and Wells Fargo and, well, we all know that Citigroup is still trying to unload the bad debt they piled into their bad bank structure.

On September 14 Moody’s downgraded two major French banks—pretty much what the company had promised in June when it placed Credit Agricole and Societe Generale on credit He watch.

At 1132 on the S&P 500 we’re again within striking range of the August low for the index at 1120. (I think this pretty much answer the question I posed a few days back of “Have we broken out of the market’s trading range?” The answer is as pretty resounding No.)

What worries me here is that we’ve got several days—the run up to the weekend’s meeting of the International Monetary Fund in Washington and then the weekend itself—of what is likely to be negative news flow. Read more