Beset by worries about a softening labor market—as evidenced by a larger than expected jump in weekly jobless claims—and general jitters about the health of the U.S. economy and financial system, the stock market took a pounding (BusinessWeek.com, 9/4/08) on Sept. 4, with the Dow Jones industrial average tumbling more than 300 points. The bond market rallied as investors sought the relative safety of U.S. Treasuries.
One of the things that weighed on investor sentiment: a stark warning from PIMCO bond guru Bill Gross. Here's what Gross, Wall Street strategists, and Federal Reserve officials had to say about the state of the markets and the economy on Sept. 5, as compiled by BusinessWeek and Standard & Poor's MarketScope staff:
William H. Gross, managing director, PIMCO
Common sense can lead to no other conclusion: If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury—not only to Freddie [Mac] (FRE) and Fannie [Mae] (FNM) but to mom and pop on Main Street U.S.A., via subsidized home loans issued by the FHA and other government institutions. A 21st century housing-related version of the [Resolution Trust Corp.] such as advocated by Larry Summers among others could be another example of the government wallet or balance sheet that is required during rare periods when the private sector is unable or unwilling to step forward.
…The bill for our collective speculative profligacy, obvious in the deflating asset markets, can be paid now or it can be paid later. Those aspiring for a perfect 800 on the Wall Street policy exam would conclude that the tab will be less if paid up front, than if swept under a rug of moral umbrage intent on seeking retribution for any and all of those responsible. Now that the Fed has spent 12 months proving that it "knows something"… it is time for the Treasury to do likewise.
Chris Burba, technical analyst, Standard & Poor's
There is a common pattern that occurs on days when the market gaps down hard and keeps going lower, amid very weak internals and TRIN (BusinessWeek.com) above 1.2. It's a bit like an earthquake, followed by a calm, and completed with an aftershock. After the initial wave of selling is exhausted, price forms what appears to be a convincing base that could reverse the intraday downtrend (usually late morning to early afternoon).…The market does indeed start to recover but doesn't get very far. Price then consolidates for a relatively long period, often an hour or two. Finally, the area of consolidation gives way, and sellers take the market below morning lows; this often occurs in the final hour of the session.
This pattern is a fake-out at its best.…When there are no more weak buyers left to hold the market up off of the morning lows, sellers take charge again, and all of that supply sends price down sharply in late trading. Buyers who thought they got in at great levels are caught in the headlights and flood the market with a second wave of selling.
Tony Crescenzi, chef bond market strategist, Miller Tabak
The January fed funds future is priced for just 14% odds that the Fed will hike the funds rate by 25 basis points by the end of 2008, the lowest odds of a hike since the notion of a hike began seeping into the market after the Fed's last rate cut on Apr. 30. No hike is seen until next April, with the market placing 78% odds on a hike occurring by that time. Additionally, the market sees the funds rate at 2.295% in mid-2009 (up from 2%, currently), down 5.5 basis points on the day.
Today's drop in rate hike odds partly reflects [the 15,000 rise in weekly initial] jobless claims. The sharp lowering of rate hike odds seen in recent weeks is in response to expectations for much weaker economic growth in the quarters ahead, particularly in the final quarter of the year and the first quarter of 2009, as well as improvements in the inflation outlook stemming from the weaker economy, the dollar rally, and lower commodity prices. Rate hike odds might switch toward rate cut odds if employment statistics indicate deepening economic weakness, and this seems a fair bet based on the elevated level of jobless claims. Barring a substantial weakening of economic conditions, however, the Fed would be best served resisting any clamoring for interest-rate cuts and instead defending the new, lower inflation rate that evolves from economic and financial conditions, lest the inflation rate accelerate again.
San Francisco Federal Reserve President Janet Yellen said the U.S. credit crunch is "severe" and could be "deepening" in her Sept. 4 speech on "The U.S. Economic Situation and Challenges for Monetary Policy." She continues to look for sluggish growth through the second half of the year. She's concerned that house prices may have to decline further before reaching bottom, but she does see some tentative signs of stabilization in new home sales. Inflation expectations have been relatively "well contained," but while inflation risks have diminished recently, they are still at the forefront of concerns. The drop in commodities and the slack in the labor force should damp inflation pressures, and she expects prices to decelerate to just over 2% by next year.
Dallas Fed President Richard Fisher said consumer price trends are the worst in about 26 years, and he believes there is about a 50% chance that inflation will accelerate, according to comments from his Sept. 4 speech in Houston. He also said growth is likely to remain anemic through the rest of this year as the housing sector has yet to hit bottom. He also acknowledged that creditors are tightening their standards. But, he is not sure if the slower growth will help mute price pressures.