The Fed's gloomy words on the economy left the market with a sinking feeling that's likely to spill into Thursday.
Coupled with worry about Europe and Moody's downgrade of major banks, the Fed's Wednesday statement left markets dazed and confused. It also ignited a massive buying spree in Treasurys, as traders positioned for the Fed's "Operation Twist" and reacted to the Fed's comments.
"I just think that within the Fed statement, the level of concern in the tenor of the statement was perhaps a bit more than anticipated. In other words, the Fed sounded nervous," said Cantor Fitzgerald market strategist Marc Pado.
On Thursday, traders will be watching the weekly jobless claims data at 8:30 a.m. ET, expected to be 425,000 after rising to 428,000 last week.
"As long as we stay below 425,000, I think we'll be okay," said Pado.
There are also leading economic indicators and the FHFA home price index at 10 a.m. ET. There are also a few important earnings—economic bellwether FedEx reports ahead of the opening bell, as does Discover Financial . Nike reports after the close.
As expected, the Fed Wednesday said it would replace $400 billion of the shorter duration Treasury securities it holds with the same amount of 6- to 30-year Treasurys. It went a step further than expected and said it would buy mortgage securities with the runoff from maturing mortgages in its portfolio. But it also talked about a slow recovery, slow improvement in unemployment and new risks from Europe.
The Fed said, "there are significant downside risks to the economic outlook, including strains in global financial markets."
Traders are also concerned that the Fed's efforts will not result in much improvement to the economy.
Michael Darda, market strategist and chief economist at MKM, said in a note the market was confused by the Fed's action and what it's trying to achieve. Low long rates and a flat yield curve are typically signs of an unhealthy economy.
Darda said the Fed may be forced to take stronger action at some point if Europe's debt crisis causes a global credit shock or China slows down too sharply.
"Perhaps the next round of support will come in the form of an explicit goal for boosting nominal GDP back to its trend level, meaning previous and future Fed balance sheet expansion would be permanent, up to a point. This would be likely to have much more force, but don’t expect to see it anytime soon, given: (1) discord on the FOMC (with three dissents); (2) a toxic political backdrop heading into what is likely to be a very contentious election next November; and (3) the Fed’s assumption that growth may still pick up some steam during the second half," he wrote.
The Fed action Wednesday also came a day after Republican leaders in Congress sent a letter to Fed Chairman Ben Bernankeasking him to refrain from further stimulus.
The unusual act ruffled some in the markets who took it as an assault on the Fed's independence.
"I think what's happened is there's clearly a level of frustration, and understandably so, with politicians of both sides, and the frustratingly slow pace of the economic recovery. Some believe the Fed's actions are delaying the process. To the extent you had over the last 10 months, a fairly dramatic decline in the dollar, there is a case to be made for quantitative easing negatively impacting the economy through higher commodities costs, particularly energy," said Deutsche Bank chief U.S. economist Joseph LaVorgna.
Political attacks on the Fed have been expected and are also expected to continue into the election, as Darda notes, but a number of economists Wednesday said they do not expect it to affect the Fed's behavior.
"It's never good to attack the central bank, regardless of your political stripes because independent central banks always perform better than those that are not," LaVorgna said.
Treasury yields slid, with the 10 year yielding just 1.871 and the 30-year at 2.999 percent after the Fed announcement. Stocks tumbled, with the Dow down 283 points to 11,124 and the S&P 500 falling 35 or 2.9 percent to 1166. The Nasdaq, lifted by tech buying early, was down hard, losing 52 points or 2 percent to 2538. Of the 10 biggest S&P sectors, financials were the worst, losing 4.9 percent, and tech was the best, down only 1.3 percent.
"When you look at the internal rotation, it's not as bad a picture as it seems ... energy is in the middle ... retail is in the middle. If this was institutional selling, it would have been led by tech," said Pado. "It's more trader types (selling)."
"If we open lower to start the day, I think calmer heads may prevail. When we get this type of selloff it presents a buying opportunity," he said.
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