Fed pledges very low interest rates for two years; stocks rally

August 9, 2011

The stock market staged a dramatic rebound Tuesday, recording the biggest gains after the Federal Reserve announced it would keep its ultra-low interest rate policies in place for two more years.

The surge ended a wild day of trading in which the Dow Jones industrial average dipped in and out of negative territory four times, giving back hundreds of points in early gains before finishing the session up 429 points. That represented a nearly 4 percent rise, the largest increase in two years.

Investors seemed uncertain about what to make of the announcement by the Fed’s main policymaking board, which for the first time set a firm date for maintaining its near-zero target for short-term interest rates. This move could provide businesses and consumers with greater certainty about the availability of low-cost borrowing as they consider making investments or major purchases, such as homes or autos.

At the same time, the Fed declined to make any significant new efforts to bolster the nation’s flagging recovery. A rare dissent by three of the policy committee members to the interest rate decision signaled that it could prove hard for the central bank to take more dramatic steps in the coming months to lift the economy and prop up the financial system.

Wall Street investors and others had been especially interested to see whether the Fed would embark on a new round of massive bond purchases aimed at invigorating the economy. Although the Fed has carried out two rounds of “quantitative easing,” or QE, central bank leaders remain reluctant to pump hundreds of billions of dollars more into the economy, because they are skeptical about whether doing so would have much effect and worry that it could spark inflation.

The Fed board, however, was quite frank about its fears for the recovery, acknowledging that “economic growth so far this year has been considerably slower” than the committee had expected and that threats to the economy have mounted.

Weaker growth

In the past few weeks, new economic indicators have shown that growth was much weaker in the first half of the year than previously thought, that job creation has been soft in the past few months, and that the manufacturing sector is slowing. The U.S. economy appears at greater risk of falling back into recession.

“Indicators suggest a deterioration in overall labor market conditions in recent months,” said a statement by the Federal Open Market Committee. “Household spending has flattened out, investment in nonresidential structures is still weak and the housing sector remains depressed.”

Those discouraging indicators, coupled with growing anxiety about a spreading debt crisis in Europe, contributed to a string of stock market losses. The Dow fell by more than 9 percent in the three trading days before Tuesday.

Investors ultimately cheered what they heard from the central bank.

“It is giving people a whole lot of clarity as to what the Fed is going to do,” said Michael Skordeles, chief market strategist at Morgan Keegan.

Even the modest step of promising to keep very low interest rates in place through summer 2013 provoked sharp disagreement on the board. The three dissenting votes were the most since 1992. Richard W. Fisher, Narayana Kocherlakota and Charles Plosser, presidents of the Federal Reserve banks in Dallas, Minneapolis and Philadelphia, respectively, preferred not to put a specific time on the low-rate plans.

The Fed had previously said only that rates would remain low for an “extended period,” which was widely taken to mean a few months. With the announcement that the rates will almost certainly be in place for the next two years, interest rates fell sharply in trading Tuesday.

The interest rate on two-year Treasury securities fell to 0.2 percent, from 0.26 percent. Rates on 10-year Treasury bonds, which move closely in tandem with home mortgage rates, had a remarkably volatile afternoon, swinging from 2.4 percent just before the Fed’s announcement to near an all-time low of 2.03 percent to end the day down more modestly, at 2.27 percent.

The decline in interest rates on Treasury bonds was especially striking, because it reflected continuing demand for the securities even after Standard & Poor’s downgraded the U.S. credit rating on Friday, raising questions about whether the bonds were as safe a bet as investors had long assumed. Investors poured their money into Treasurys on Monday, the first trading day after the downgrade, essentially saying that U.S. bonds remain among the safest at a time when economic troubles are menacing economies on both sides of the Atlantic Ocean.

In Europe, efforts by the European Central Bank to contain the continent’s debt crisis made progress on Tuesday. For the second day in a row, the rates that Italy and Spain pay to borrow money fell. The ECB began buying debt of the two countries this week to keep them from succumbing to the same financial contagion that has infected Greece, Ireland and Portugal.

European stock exchanges were mostly up Tuesday, with the British market up 1.9 percent, the French up 1.6 percent, and the Italian up 0.5 percent. The exceptions were the German stock market, which was down 0.1 percent, and the Spanish, down 0.4  percent.

Asian markets opened higher early Wednesday. Japan’s blue-chip Nikkei-225 index ended its morning session up nearly 1.2 percent.

Investor uncertainty

The wild swings on stock and bond markets reflect investors’ uncertainty about the health and direction of the global economy. Each fragment of news has the potential to set off major movements as investors extrapolate about what the new information could mean for the economy.

The Fed statement, issued shortly after 2:15 p.m., included no major surprises. But it sparked a brief rise in stock prices, followed by a swift collapse, and then steep gains — all within half an hour.

“The market was being driven almost entirely by the Fed,” said Julia Coronado, chief North American economist for BNP Paribas. “There was a drop as people digested the statement, and then a rally as they concluded it means that the Fed is open to easing monetary policy more.”

Although Fed Chairman Ben S. Bernanke may have a hard time persuading the board to take more ambitious steps to boost the economy, the committee left the door open.

The panel “discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability,” the statement said. The panel will continue to assess the economic outlook “and is prepared to employ these tools as appropriate.”

The last round of quantitative easing, a $600 billion bond-buying program, ended in June. If the Fed’s grim prognosis for the economy is correct, this could increase pressure on the central bank to take new steps.

“The Fed is saying that we’re going to be either backtracking or making much less progress toward reducing unemployment than we thought before,” Coronado said. “That should mean they have a pretty strong bias toward more easing.”

Staff writer Cezary Podkul contributed to this report.

SECTION: {section=business, subsection=economy}!!!
INITIAL commentConfig: {includereply=true, canvas_permalink_id=washpost.com/8bvh5zpd9k, allow_comments=true, commentmaxlength=2000, includeshare=true, display_comments=true, canvas_permalink_app_instance=m6yzjj840m, display_more=true, moderationrequired=false, includefeaturenotification=true, canvas_allcomments_id=washpost.com/km4ey0dajm, comments_period=3, defaultsort=reverseChronological, includevoteofftopic=false, allow_videos=false, includesorts=true, markerdisplay=post_commenter:Post Commenter|staff:Post Writer|top_commenter:Post Forum|top_local:Washingtologist|top_sports:SuperFan|fact_checker:Fact Checker|post_recommended:Post Recommended|world_watcher:World Watcher|cultuer_connoisseur:Culture Connoisseur|weather_watcher:Capital Weather Watcher|post_contributor:Post Contributor, childrenitemsperpage=3, includeheader=true, includeverifiedcommenters=true, defaulttab=all, includerecommend=true, includereport=true, maxitemstop=15, source=washpost.com, allow_photos=false, maxitems=3, display_ugc_photos=false, includepause=true, canvas_allcomments_app_instance=6634zxcgfd, includepermalink=false}!!!

UGC FROM ARTICLE: {allow_comments=true, allow_photos=false, allow_videos=false, comments_period=3, comments_source=washpost.com, default_sort=, default_tab=, display_comments=true, is_ugc_gallery=false, max_items_to_display=3, max_items_to_display_top=15, moderation_required=false}!!!

FINAL commentConfig: {includereply=true, canvas_permalink_id=washpost.com/8bvh5zpd9k, allow_comments=true, commentmaxlength=2000, includeshare=true, display_comments=true, canvas_permalink_app_instance=m6yzjj840m, display_more=true, moderationrequired=false, includefeaturenotification=true, canvas_allcomments_id=washpost.com/km4ey0dajm, comments_period=3, defaultsort=reverseChronological, includevoteofftopic=false, allow_videos=false, includesorts=true, markerdisplay=post_commenter:Post Commenter|staff:Post Writer|top_commenter:Post Forum|top_local:Washingtologist|top_sports:SuperFan|fact_checker:Fact Checker|post_recommended:Post Recommended|world_watcher:World Watcher|cultuer_connoisseur:Culture Connoisseur|weather_watcher:Capital Weather Watcher|post_contributor:Post Contributor, childrenitemsperpage=3, includeheader=true, includeverifiedcommenters=true, defaulttab=all, includerecommend=true, includereport=true, maxitemstop=15, source=washpost.com, allow_photos=false, maxitems=3, display_ugc_photos=false, includepause=true, canvas_allcomments_app_instance=6634zxcgfd, includepermalink=false}!!
Comments
SECTION: {section=business, subsection=economy}!!!
INITIAL commentConfig: {includereply=true, canvas_permalink_id=washpost.com/8bvh5zpd9k, allow_comments=true, commentmaxlength=2000, includeshare=true, display_comments=true, canvas_permalink_app_instance=m6yzjj840m, display_more=true, moderationrequired=false, includefeaturenotification=true, canvas_allcomments_id=washpost.com/km4ey0dajm, comments_period=3, defaultsort=reverseChronological, includevoteofftopic=false, allow_videos=false, includesorts=true, markerdisplay=post_commenter:Post Commenter|staff:Post Writer|top_commenter:Post Forum|top_local:Washingtologist|top_sports:SuperFan|fact_checker:Fact Checker|post_recommended:Post Recommended|world_watcher:World Watcher|cultuer_connoisseur:Culture Connoisseur|weather_watcher:Capital Weather Watcher|post_contributor:Post Contributor, childrenitemsperpage=3, includeheader=true, includeverifiedcommenters=true, defaulttab=all, includerecommend=true, includereport=true, maxitemstop=15, source=washpost.com, allow_photos=false, maxitems=3, display_ugc_photos=false, includepause=true, canvas_allcomments_app_instance=6634zxcgfd, includepermalink=false}!!!

UGC FROM ARTICLE: {allow_comments=true, allow_photos=false, allow_videos=false, comments_period=3, comments_source=washpost.com, default_sort=, default_tab=, display_comments=true, is_ugc_gallery=false, max_items_to_display=3, max_items_to_display_top=15, moderation_required=false}!!!

FINAL commentConfig: {includereply=true, canvas_permalink_id=washpost.com/8bvh5zpd9k, allow_comments=true, commentmaxlength=2000, includeshare=true, display_comments=true, canvas_permalink_app_instance=m6yzjj840m, display_more=true, moderationrequired=false, includefeaturenotification=true, canvas_allcomments_id=washpost.com/km4ey0dajm, comments_period=3, defaultsort=reverseChronological, includevoteofftopic=false, allow_videos=false, includesorts=true, markerdisplay=post_commenter:Post Commenter|staff:Post Writer|top_commenter:Post Forum|top_local:Washingtologist|top_sports:SuperFan|fact_checker:Fact Checker|post_recommended:Post Recommended|world_watcher:World Watcher|cultuer_connoisseur:Culture Connoisseur|weather_watcher:Capital Weather Watcher|post_contributor:Post Contributor, childrenitemsperpage=3, includeheader=true, includeverifiedcommenters=true, defaulttab=all, includerecommend=true, includereport=true, maxitemstop=15, source=washpost.com, allow_photos=false, maxitems=3, display_ugc_photos=false, includepause=true, canvas_allcomments_app_instance=6634zxcgfd, includepermalink=false}!!
Show Comments
Most Read Business