Low Consumer Confidence Unlikely to Motivate the Fed; Stocks Plunge

By Jason Simpkins
Staff Writer

Worries about the strength of the U.S. economy coupled with questions about the central bank’s willingness to intercede sent shares into an outright freefall yesterday (Tuesday), with the Dow Jones Industrial Average shedding more than 280 points. The bellwether 30-stock Dow plunged 280.28 points – or 2.1% – to close at 13,041.85, its biggest one-day drop since Aug. 9.

The other indexes fared even worse.

The Standard & Poor's 500 Index skidded 34.43 points, or nearly 2.4%, to reach 1,432.36. The high-tech-laden Nasdaq composite index dropped 2.4%, shedding 60.61 points and closing at 2,500.64.

Economic worries had share prices in negative territory all day.

In recent days, investors have increasingly convinced themselves – with no real evidence to base their assumptions on – that U.S. Federal Reserve policymakers will be willing to cut interest rates soon to restore an economy increasingly sinking under the weight of high energy costs, falling home prices and a credit crunch that’s becoming a global contagion.

But it’s possible that that central bank sent a stronger-than-intended signal that they would be willing to cut interest rates to help calm turbulent market conditions. In the minutes from the Federal Open Market Committee's Aug. 7 meeting – while the central bank noted the turmoil in the markets, and said that "to the extent such a development could have an adverse effect on growth prospects, might require a policy response" – the FOMC never once discussed a cut in the benchmark Federal Funds rate that much of Wall Street has wanted.

[However, Money Morning Investment Director Horacio Marquez told readers last week that he believed the Fed had not entertained the notion of a Fed Funds rate cut. To read that analysis, click here].

However, it’s also true that the Aug. 7 FOMC meeting predated a number of actions subsequently taken by the central bank in an effort to temper the wild swings in stock prices that have sent investors back on their heels – including the Aug. 17 lowering of the Discount Rate, the rate the Fed charges banks that borrow money. After some apparent initial benefits, Wall Street has started a veritable drumbeat for a reduction in the Fed Funds rate – what Fed-member banks charge one another for overnight loans needed to meet short-term reserve requirements.

After an initially calmer week following that move, market volatility has returned to earlier levels, and now may be trying to force the Fed to act, The Associated Press reported.

"Investors are getting whipped side-to-side because their expectations, which are changing almost on a daily basis, aren't being met," Chris Johnson, chief investment strategist at Johnson Research Group, told The AP. "We've gone from ‘The roof is on fire’ to ‘The Fed is riding in on a white horse’ – and what we’re seeing now is a reality check.

Joel Naroff, president and chief economist for Naroff Economic Advisors Inc., in West Chester, Pa., hadn’t yet seen the Fed minutes when he made his commentary very early in the day yesterday. But even then Naroff was insightful enough to observe: “The hopes that the FOMC will cut rates before the September 18th meeting look to be disappearing, but I still don’t rule out a rate reduction then … It makes sense to do that as this is a credit issue and the credit reduction is not going away.”

Naroff was concerned about the fact that the Conference Board reported that consumer confidence sagged in August because of the stock-market swings, and that a Standard & Poor's housing index showed that U.S. home prices in the second quarter posted their sharpest decline since 1987. In early trading yesterday, all the bad news caused the dollar to skid to levels not seen in 12 months.

The Consumer Confidence Index was especially troubling, given that this was the biggest drop the index has suffered since the aftermath of Hurricane Katrina in September 2005. In response, the U.S. dollar continued its decline, falling 0.6% against the yen. The euro was up 0.7% and the British pound remained flat. Still, few economists believe it will be enough to prompt the Fed to act. 

Falling from 111.9 in July to 105 in August has brought the Consumer Confidence index to a low it hasn’t seen in a year. Those polled who said that business conditions are "good" decreased to 26.4% from 28.3% in July, while those saying conditions are "bad" increased to 16.3% from 14.5%. Those who described jobs as "hard to get" increased to 19.7% from 18.7%, while those who saw jobs as "plentiful" decreased to 27.5% from 30.0 percent in July.

Consumer spending accounts for as much as 70% of the U.S. economy’s yearly activity, so a slump in consumer confidence is not seen as a harbinger of good things to come.

However, the index remains relatively high from a historical standpoint, and many analysts had forecast a larger drop, given the amount of publicity surrounding the housing market and the credit crunch.

“It should surprise no one, even the researchers at the Fed, that consumer confidence took a hit in August,” Naroff, the economist, told Money Morning. “It is really a wonder that households didn’t become totally depressed.”

They didn’t.  In fact, confidence levels concerning household expectations for income remained unchanged. Ultimately the news from the Conference Board was bad – but not horrible – which didn’t bode well for rate cut prior to the Sept. 18 FOMC meeting. And that was before the Fed minutes had been released and were factored in by investors; once that happened yesterday, it was as if a trap door were sprung beneath investors’ feet.

The sell-off was broad-based: Declining issues beat out advancers by a 3 to 1 basis on the New York Stock Exchange. Volume was heavy: 2.96 billion shares changed hands, compared to 2.35 billion on Monday.

Overseas, The AP reported, Japan's Nikkei stock average fell 0.09%, while China's Shanghai Composite Index gained 0.91% to set another closing record. In afternoon European trading, Britain's FTSE 100 fell 1.9%, Germany's DAX index fell 0.74%, and France's CAC-40 fell 2.1%.

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