Stock indexes fall sharply in reaction to Fed's move

February 05, 1994|By Ian Johnson | Ian Johnson,New York Bureau of The Sun

U.S. stocks took their biggest one-day fall in more than two years yesterday after investors learned that the Federal Reserve had moved to increase interest rates.

The most widely watched stock index, the Dow Jones industrial average, fell 96.24 points, or 2.43 percent, its biggest drop since a 120-point fall on Nov. 15, 1991. The broader Standard & Poor's 500 index was down 2.3 percent, while small stocks were hit even harder, with the Nasdaq composite index slumping 2.57 percent.

The drop was triggered by comments made by Federal Reserve Board Chairman Alan Greenspan, who said yesterday morning that the Fed had decided to increase a key lending rate.

Market analysts and strategists cautioned against reading too much into the market's action, pointing out that the Fed's move was just a catalyst for a long-expected retreat in stock prices.

The Dow's drop of 96 points, while the eighth-largest one-day loss in points in stock market history, was far smaller than other famous one-day falls. On "Black Monday" in 1987, the Dow dropped 23 percent, after a 4.6 percent loss on the preceding Friday.

"This is a good shake-up of the market, but not the correction that everyone has talked about," said Peter Canelo, chief investment strategist at NatWest Securities Corp.

Mr. Canelo said stock investors are most worried that the Fed's interest-rate increase is just the start of a gradual nudging-up of interest rates over the coming months.

The Fed said that it was taking a one-time pre-emptive strike against inflation with its move yesterday, but market observers are conditioned to believe otherwise, said Andrew B. Williams, a portfolio manager with the Glenmede Trust Co. in Philadelphia.

"It's not up a quarter this month and down the next. It's usually up each month. What Greenspan is saying is an entirely new strategy," Mr. Williams said. "People are thinking that we've reached the low tide in interest rates, and now they can only go up."

Market confusion over the Fed's action was also reflected in the bond market's reaction, where falling prices raised the yield on the benchmark 30-year government bond to 6.35 percent yesterday, from 6.31 percent Thursday.

Under normal circumstances, the Fed's actions would have raised long-term bond prices, thus lowering that yield, because it would be interpreted as a sign that the Fed is serious about fighting inflation, said A. Gary Shilling of Shilling and Co. in New Jersey.

But long-term bond prices fell because the Fed's actions will almost certainly cause interest rates on bank accounts and certificates of deposit to increase. This will make them more attractive to investors than long-term bonds.

This could give consumers the message that if they want to borrow money cheaply, they'd better do it now, Mr. Shilling said.

That could trigger a flood of mortgage applications and purchases, he said, and drive up inflation -- exactly what the Fed was trying to avoid.

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