Wednesday, August 25, 2010


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OVERVIEW ~ August 9 through August 13 ~ The markets acted as they do when investor optimism gives way to pessimism, with a rush to the safe haven of U.S. Treasury securities (and a resulting further decline in interest rate yields), further investment in gold, and a sell-off of the euro, which fetched $1.3228 at the beginning of the week and $1.2573 at the end. The Dow Jones Industrial Average stumbled into the trend as well, losing 3.3% on the week. The Freddie Mac average for its 30-year fixed-rate mortgage edged down another 5 basis points to 4.4%. In other words, it was a generally unimpressive week for all investments other than Treasury securities and gold.

FOCUS ~ The big drop in stock market indices occurred on Wednesday, August 11. The Dow Jones Industrial Average (DJIA) fell 265.42 points, 2.5% of its prior level. Why?

The Federal Reserve’s Open Market Committee had announced three things at its regularly scheduled meeting the day before. First, it said that the economy was indeed moving forward, but very slowly. Second, therefore, it reaffirmed that it would keep the fed funds rate (the rate at which banks borrow from one another overnight) at its current low level for the foreseeable future. Third, it announced that it planned to use the proceeds of the maturing mortgage-backed securities (MBSs) it has invested in to purchase Treasury securities. The earlier purchases were designed (successfully) to help keep the MBS markets liquid and mortgage rates low. The newly announced move would be designed to help keep Treasury security interest rates low and to help stimulate further economic recovery.

At first, markets over the world seemed pleased at the Fed’s decision. Then, concerns set in. Investors seemed to realize that the Fed was implicitly suggesting that there might be trouble ahead. Enough of a panic ensued to create Wednesday’s big stock market decline.

Meanwhile, world investors grew more worried about a possible resurgence of debt problems abroad (and even about a weakening market for foreign goods in China), and world stock market indices fell, along with the euro, which has been losing value against the dollar whenever worries about European economies increase.

Most likely, none of the week’s economic worries, taken alone, would have moved the markets as strongly. But the markets are uncertain enough to be very vulnerable to a collection of investor concerns, and we saw what the results of those concerns look like.

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