Federal Reserve policy-makers left a key-interest rate unchanged yesterday at a 40-year low but opened the door to a cut later by saying the risks of economic weakness outweigh the prospects of inflation.
Though the Fed's announcement had been expected, Wall Street was disappointed. All three major indexes were down more than 2 percent for the day.
"It signals that they are concerned about the economy's plight, but they are not panicked," said Mark Zandi, chief economist with Economy.com in West Chester, Pa. "They feel that what they've done so far, along with continued strong productivity growth, will be enough to push the recovery forward."
The federal-funds rate, which banks charge one another for overnight loans, remains at 1.75 percent. The rate is important to consumers, too, because changes in it ripple through the economy and affect how much they pay for auto loans and credit card debt.
In a statement announcing its decision, the Federal Open Market Committee said the slowdown in spending that "emerged this spring has been prolonged in large measure by weakness in financial markets and heightened uncertainty related to problems in corporate reporting and governance."
The policy-makers said current monetary policy and productivity growth should be enough to foster a better business climate over time. But in a shift of position, they said that for the foreseeable future, "the risks are weighted mainly toward conditions that may generate economic weakness."
The stock markets were quiet yesterday before the Fed announcement at 2:15 p.m. Afterward, stocks fell sharply, mostly in the last hour of trading.
The Dow Jones industrial average, an index of 30-blue chip stocks, fell 206.50 points, or 2.38 percent, to 8,482.39. The Nasdaq composite index, a technology bellwether, lost 37.56 points, or 2.87 percent, to close at 1,269.28. The broader Standard & Poor's 500 index was off 19.59 points, or 2.17 percent, and closed at 884.21.
Last week, the prospect of an interest-rate cut helped fuel triple-digit gains in the Dow three days in a row.
"There is still some uncertainty out there in regards to the overall economic condition. We didn't have great numbers today on retail sales," said Matt Wilson, a financial consultant with Salomon Smith Barney in Baltimore. "It's a fear factor out there with individual investors."
Patrick Buttarazzi, vice president of investments at Prudential Securities in Baltimore, said yesterday's sell-off might have been a case of investors buying on rumors and selling on fact.
"The rumor is they will cut rates. The fact is they didn't," he said. "[Investors are saying] `now is the time to walk away.'"
Policy-makers will meet three more times this year, beginning with a meeting Sept. 24. Economists don't expect a rate cut before then.
"They really need another month of data before they jump on this, unlike some in the financial markets who were calling for [a cut] today," said Diane Swonk, chief economist at Bank One in Chicago.
"The Fed will cut rates sooner rather than later," said Alan Ackerman, market strategist with Fahnestock & Co., a New York brokerage. He predicts that the federal funds rate will be a half-point lower by the end of the year.
One troubling sign on the horizon is a corporate credit crunch as banks tighten their lending policies, Ackerman said.
"We're in a period now where bankruptcies are coming at us fast and furious," he said.
Some economists say there is no need for a cut.
"What benefit are we going to get out of a quarter-point or half-point interest rate cut from the Fed? The benefits are dubious," said Sung Won Sohn, chief economist with Wells Fargo & Co. in Minneapolis. Even if policy-makers cut the rate, the effect won't be felt until a year later, Sohn said.
"On the other hand, there are some risks. It could send the wrong message to the marketplace that the economy is not only weak but it will be weaker," he said.
Even without a rate cut, the stock market appears to be stabilizing and the economy will recover, Sohn said. "We will have moderate economic growth. It's not going to be a barn-burner," he said.
Zandi sad he is concerned that with the federal-funds rate so low, an additional rate cut could hamper the Fed's response to a major financial crisis calling for a significant cut.
Elsewhere on the broad market, the Russell 2000 index, a benchmark of small-cap stocks, fell 10.80 to 377.76 and the Wilshire 5000 total market index slumped 181.75 to 8,355.46. Based on changes in the Wilshire, the market value of U.S. stocks declined by $218 billion.
The Sun-Bloomberg index of the top stocks in Maryland fell 2.95 to 178.36. Lockheed Martin Corp. tumbled $2.26 to $63.18 and MedImmune Inc. lost $1.71 to $27.88.
Declining issues outnumbered advancing ones by about 5-to-2 on the New York Stock Exchange. Volume on the Big Board came to 1.31 billion, up from 1.04 billion Monday.