Stock prices collapsed today in the face of a sharp jump in short-term interest rates and a general nervousness among investors that the 17-week stock market rally had to come to an end.
The Dow Jones Industrial Average of 30 stocks closed down 18.09 to 948.63. The New York Stock Exchange composite index off 1.32 to 70.75. Both indices lost about 1.8 percent during today's trading.
At the same time money market rates jumped sharply, following an announcement Friday that the money supply grew by more than $8 billion during the week ended Aug. 6. Even though much of the jump was a fluke -- related to an early payment of Social Security benefits and a change in seasonal adjustment factors -- many investors feel the Federal Reserve will have to take a tougher stance on monetary policy to counteract recent increases in money.
William Sullivan, vice-president of the Bank of New York, said that since 3 p.m. Friday -- when most trading desks closed for the weekend -- bond prices have fallen about $15 on a $1,000 face value and interest rates on Treasury bills have risen between 50 and 70 basis points (a basis point is 1/100 of 1 percent). The Fed money supply announcement came at 4 p.m.
Sullivan said there was evidence that the Federal Reserve was taking a tougher monetary posture today, allowing the so-called federal funds rate to rise as high as 10 percent before supplying reserves to the banking system.The federal funds rate is the interest banks charge each other for overnight loans of excess reserves and is a rate over which the Federal Reserve has a strong influence.
There was, however, one bright light on an otherwise dreary day on Wall Street. The U.S. dollar closed higher against all major currencies, in large part because foreign investors believe that higher interest rates here make it attractive to invest in dollar assets.
Because of the high interest rates in the U.S. last winter and spring, the dollar gained in value, only to fall again as interest rates dropped sharply from record levels rates began to rise again last month, the dollar has been edging up in value and rose sharply today.
Jerry Hinkle, chief stock trader at Sanford C. Bernstein & Co., said that he doubted the surge in money growth reported last week played a major role in today's steep decline in market prices, the biggest since the Dow average dropped 19.71 on March 24.
"The market is undergoing the correction people have been waiting for," Hinkle said. The Dow average had risen more than 200 points between April 16 and last Friday. Even though many investment strategists think stock prices will continue to rise for several years, all long-term trends have intervals in which prices rise or fall.
On the New York Stock Exchange today, 1,382 stocks declined in value while only 269 closed higher. Stock prices opened down sharply, rallied at mid-day, then plummeted again in the final hours of trading.
Trading volume also declined. About 42 million shares of stock changed hands on the New York Stock Exchange today, while nearly 48 million shares were bought or sold last Friday.
On the American Stock Exchange, the index was down 6.35 to 318.71. Losers overwhelmed gainers by 500 to 165.
Patrick Savin, of Drexel Burnham Lambert Inc., said that the nervousness in the money markets is exaggerated. He noted that the Federal Reserve has been moving since early July to tone down the growth of bank reserves and that it takes some time for that stringency to show up in the money supply itself. "There is an assumption in the money markets that a recovery is imminent and that interest rates will rise immediately. Both assumptions are questionable," Savin said.
Savin said that when the steps the Fed has taken already show up in the money supply figures, interest rates will fall again.
The money supply is a prime factor in both inflation and economic production. When the money supply rises too fast, prices rise as well. The Fed, in recent months, has been concentrating its open market activities -- buying and selling government securities -- on trying to control money growth rather than worrying about interest rates as it used to.
When the Fed buys government securities it pumps funds into the banking system off which banks can make loans. When it sells securities it absorbs funds banks might otherwise lend.
The immediate result of the Fed's activities shows up in the federal funds rate, which closed about 9.75 percent today, compared with 9 percent most of last week.