Nerve-Jolting Ride in the Markets : The Fed must signal stability in interest rates
The financial markets appeared to have weathered the worst of a widely expected selloff on Monday, with the Dow Jones industrial average falling 42.61 points. However, some unnerving seesawing in the markets--triggered by rising interest rates and, ironically, favorable economic indicators--is likely to continue for a while.
The situation is downright disconcerting for most of those with investments in stocks, bonds and mutual funds. The stock market was due for some correction, but the sudden and sharp run-up in long-term interest rates had not been foreseen.
The Federal Reserve nudged up short-term rates twice in the last month, a quarter percent each time, to squeeze out “a speculative development in the financial markets” and as a preemptive strike against inflation. The bond market went ballistic during the same period, with long-term interest rates shooting up to 7.42% on Monday.
President Clinton said on Monday that Americans should not overreact to the stock market drop because the economy was fundamentally healthy and interest rates, while too high now, would turn down again. That indeed is the conventional wisdom, assuming the markets settle down.
Interest rates, however, moved beyond 7% on Monday, possibly putting the recovery into a danger zone. “Based on what we know, our view of how strongly the economy will grow this year is not changed by an interest rate in the neighborhood of 7%,” Laura D’Andrea Tyson, chairwoman of the President’s Council of Economic Advisers, said over the weekend, “but if the level goes much above 7%, then that would exercise a contractionary effect on the economy.” That, in turn, would curtail job growth.
Such a contraction would set back California in a big way. Three years behind the rest of the nation in the economic recovery, the state is only now emerging from its worst economic downturn since the Great Depression. It’s a fragile recuperation at best, and without significant progress in California the national recovery will be hampered.
Riding the market’s roller coaster is no fun. With uncertainty in the bond market and interest rates spooking the stock market, the last thing needed now is the prospect of another, imminent hike in rates by the Federal Reserve.
Stability is what is necessary. Most investors, though nervous, are hanging in, but they want to see signals that they are not being foolhardy. The Fed, by not further increasing interest rates now, can help to quell overblown inflation fears and settle market jitters.
