Markets slide as Fed fails to reassure

Fresh turbulence hit financial markets on Tuesday as warning signs mounted for the US housing market and fears about the fallout from the crisis in credit markets drove volatility.

Sentiment darkened on the news that Federal Reserve policymakers had acknowledged that deteriorating financial conditions might require a policy response” even before it moved to staunch a liquidity crisis by lowering the rate at which it lends to banks.

The S&P 500 suffered its worst day for three weeks, falling by about 2.3 per cent while investors fled to the safety of treasuries. The dollar fell Y1.5 against the yen to Y114.3, close to its low for the year.

New figures suggested an acceleration in house price depreciation while consumer confidence suffered its worst fall since the aftermath of Hurricane Katrina two years ago.

A key measure of market volatility – the Vix index – was up 9.5 per cent for the day at 24.83.

Seth Waugh, head of Deutsche Bank’s US unit, before the release of the minutes, said markets were undergoing a dramatic repricing” but that Fed action to increase liquidity would prevent another major seizure in credit markets.

We’re at the beginning of the end of the crisis,” he said.

But Wall Street started to sell off on the housing figures and sold off further in response to the Fed minutes.

Investors instead poured money into low-risk securities. A late surge of buying pushed the yields on short-dated government paper down a further 10 basis points to 4.43 per cent – 33bp lower on the day.

The Fed minutes showed policymakers put aside concerns about the cost of credit because they were not convinced a slowdown in inflation would last.

The minutes said a further deterioration in financial conditions could not be ruled out and, to the extent such a development could have an adverse effect on growth prospects, might require a policy response.”

Members expected a return to more normal market conditions, but recognised that the process likely would take some time.”

Many investors and economists said the liquidity crisis since that meeting meant the Fed was likely to cut rates next month.

Alan Ruskin, strategist at RBS, said that at best a rate cut will be needed to maintain the nervous status quo”.


Markets slide as Fed fails to reassure

Financial Times
8/28/2007 7:06:00 PM