Fed Caution Starting to Weigh on Investors

Look no further than Friday’s stock market sell-off for evidence that the Fed’s decision to hold off on a rate hike until further notice has upset already unsettled markets.

One takeaway is that the Fed is still acting as if the economy is in deep recovery mode, but U.S. economic data has suggested otherwise. For months markets shrugged off the disparity and moved higher on the Fed’s dovish approach.

But now the Fed’s cautious pessimism is apparently starting to weigh on investors.

The Dow Jones Industrial average was off more than 1% in midmorning trading and analysts were blaming “uncertainty” wrought not only by the Fed’s decision yesterday to punt on a rate hike, but also the lack of clarity within the Fed’s September statement regarding when liftoff might be forthcoming.

“Disappointingly, forward policy guidance was lacking in the official statement, and this will likely keep uncertainty in the market on the expected timing of future policy tightening,” Brian Rehling, co-head of global fixed income strategy for Wells Fargo Investment Institute, said in a research note.

The S&P 500 and the Nasdaq were also off by about 1%, and gold, often a barometer of fear in the market, was up almost $20.

For months investors have cheered any indication that the Fed planned to keep interest rates at their near-zero level, thrilled that the easy-money generated by low borrowing costs would keep on flowing.

The Fed said in no uncertain terms Thursday that rates would not move higher until policy makers see further improvements in U.S. labor and housing markets, and until the impact of global turmoil – notably in China – on U.S. markets becomes clearer.

Friday’s sell-off suggests that investors, rather than cheering the delay in a rate hike, are more concerned with the Fed’s warnings related to slowing economic growth overseas, which represents a shift in investor sentiment.

Many analysts had suggested prior to Thursday’s announcement of a delay that the Fed’s reluctance to raise rates is sending the wrong message to markets; an overly pessimistic message that doesn’t correspond with the upward trajectory of domestic economic data in recent months.

Former Philadelphia Fed President Charles Plosser, in an interview Thursday on the Fox Business Network, said the Fed should have started raising rates a long time ago.

“I sort of made that argument for quite some time and felt like it was time to move. We still had crisis-style monetary policy in the midst of an economy that was going between or around 2.5% and [the] unemployment rate was getting close to the natural rate or what might be full employment. And it seemed to me it’s rather strange to be having a record amount of accommodation in an economy that was pretty close to the Fed’s goals and targets,” he said.

Apparently investors are now wondering what the Fed is so worried about.