After the Federal Reserve’s historic move Sunday night to bail out ailing Bear Stearns (NYSE: BSC), and Tuesday’s Fed move to cut the interest rate, stock markets responded by resuming their volatility. The markets have continued to react with intensified daily volatility as this latest period of robust buying and selling kicked into high gear last Friday, when Bear Stearns’ troubles became public. With JP Morgan-Chase (NYSE: JPM) and the Fed springing into action on the heels of Bear Stearns’ announcement of liquidity problems last week, the market averted a potentially massive sell-off on Friday. By Monday, the Fed’s additional action to fortify the Bear Stearns deal saw the markets calm temporarily, with the Dow moving up slightly more than 21 points. Tuesday, with the Fed announcement of more interest rate cuts, the market exploded for a 420 point gain in the Dow, but by Wednesday the up-and-down tug of war had again taken over, with sellers prevailing most of the day as the Dow closed down 293 points, at 12,099.66. The Nasdaq likewise fell to 2,209.96, off 58.30 points.
On Tuesday, the Fed made its sixth rate cut since last September, when it cut the federal funds rate by 75 basis points to 2.25%. This latest move brought the rate down again from last fall’s 5.25% on the key short-term interest rate that most directly affects consumer loans like mortgages, home equity loans, and auto loans. The rate cuts are intended to jump start a sluggish economy, which, depending on interpretation, has already sunk into recession or is on the verge of it. With commercial banks able to borrow at lower rates, they should eventually be more willing to lend to consumers, also at lower rates. Some banks announced they had cut their prime lending rate from 6% to 5.25% after the Fed cuts.
In a series of related moves—which some observers have called the largest moves by the Fed in over 25 years—the Fed has attempted to attack both the credit crisis and the economic slowdown, both of which are bound up in an inter-connected series of problems within and related to the capital markets and the economy, by providing not only greater ease and availability on the consumer credit front, but also greater liquidity for commercial banks and investment banks.
Critics have pointed out that, with the weaker dollar, the Fed needs to look at inflationary data like the P.P.I., where rising commodity prices have filtered into the economy via gasoline prices at the pump, food prices at the supermarket, and some consumer goods. Oil, gold, and such vital yet mundane commodities as wheat, are all having bullish run-ups in price, perhaps even approaching speculative bubbles. Historically, these speculative bubbles have eventually proven inflationary.
Criticism of the Fed bail out of Bear Stearns comes on several fronts, with some observers arguing that it was either too sweet a deal for JP Morgan-Chase, or that the Fed reacted far too slowly to rescue Bear Stearns, the fifth largest investment bank. Other critics point out that providing short-term superficial relief while courting long-term pain (by not addressing what many see as the deeper, fundamental problems in the credit market) is a mistake, and cite a marketplace where subprime mortgages, complex derivatives, and massive writedowns of these instruments have dominated financial news for the last thirteen months.
One thing of note; while the highly volatile stock market averages continue to make investors nervous, short-term traders who resist being whipsawed have found themselves with opportunities to get in and out of stocks quickly, even on what are usually considered non-speculative issues. Goldman Sachs (NYSE: GS), for example, slumped initially on the Bear Stearns news, then rallied 25 points to more than 175 on the rescue news and its own, positive earnings report, then fell back again a day later into the high 160s. Both critics and backers of the Fed’s recent moves agree on one thing; we are likely to see continued volatility in the stock markets.
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