The Fed Flinched...and Markets Shuddered

09/23/2011 9:40 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

“Never let them see you sweat!” It was a great advertising campaign for a deodorant. And the Fed should have taken that advice, writes MoneyShow.com columnist Terry Savage.

Nothing in the global economy changed overnight. But when the Fed announced it was tinkering with the interest-rate structure because it saw “significant downside risks to the economic outlook, including strains in global financial markets,” the stage was set for mass fear.

The Fed rarely, if ever, comments on global financial markets. And if the Federal Reserve Bank of the United States admits it is worried, then every other banker, lender, and investor on the planet should be worried. The results showed up in all global markets.

Fed Flinched

Had the Fed merely restated its previous economic concerns, but left policy alone, the markets would have yawned. But the Fed flinched.

This time the Fed was specific about its worries. For the first time in recent years, the Fed’s statement referred to its dual mandates of low inflation and maintaining full employment. In other words, the Fed was acting because it was worried about jobs.

And the Fed specifically said it would take action to try to depress long-term interest rates to help the mortgage market—a recognition that housing continues to be in a depressed state. While it is doubtful that a slightly lower mortgage rate will have much impact, the very fact that the Fed is making this move indicates their increasing concern.

Market Madness

The markets reflect one great fear—a global recession, which would impact the entire financial system.

Everyone rushes for safety. And these days “safety” is defined as “cash”—and specifically US dollars, in very-short-term government Treasury bills. No one wants to own anything “risky.”

If a global recession is imminent, no one needs to use more oil. No one expects better corporate earnings, so no reason to buy stocks. No one wants to lend. And no one wants to own risky debt.

Selling begets more selling—at much lower prices. And lower prices beget margin calls. And that means even the “good” investments have to be sold to raise cash to meet the calls. Thus, the sell-off in dividend-paying blue chips—and even in gold.

This is the same “madness” that causes people to buy irrationally at the top of markets. Now we are seeing the opposite side of that coin. 

Fear and greed can move markets to extremes that have never been anticipated. And volatility—the speed that reflects these swings of emotion—is enhanced by our ability to transmit our emotions into action almost instantaneously.

Step Back, Gain Perspective

Ten years from now, when you start withdrawing your retirement assets, you won’t be remembering today’s headlines. 

America will have moved on, in new directions, to a new definition of prosperity. You can only be part of that if you have at least a portion of your funds invested for that future.

Can you take that risk? “Risk is the price you never thought you’d have to pay.” And that’s The Savage Truth.

Related Articles on MARKETS