Market Fades As Fed Stands Pat

Federal Reserve policymakers decided Tuesday to hold U.S. interest rates steady but warned that economic risks have tilted toward weakness in a step that may foreshadow rate reductions ahead.

That decision may have been responsible for a late-afternoon sag in the stock market. Analysts blamed the stock drop on traders who, in the absence of other news, had been focusing for days on the move by the Fed. When the market began to fall shortly after policymaker's announcement, computer-generated trading exacerbated the selloff.

The Dow Jones industrial average closed down 206.50, or 2.4 percent, to 8,482.39, according to preliminary calculations.

Broader stock indicators also fell. The Standard & Poor's 500 index was down 19.59, or 2.2 percent, at 884.21, and the Nasdaq composite index was down 37.56, or 2.9 percent, at 1,269.28.

"It's the old story of sell on the news," said Larry Wachtel, market analyst at Prudential Securities. "Today was selling on the news because there's nothing coming along in the dog days of August that's going to change the psychology."

Some investors had bet the Fed would lower rates again, and they sold as the decision to leave rates unchanged was announced. Optimism that the Fed might lower rates contributed to the market's big rally last week, although much of those hopes faded over the weekend.

Some on Wall Street were disappointed the Fed did not cut rates to help underpin the economy and avoid a double-dip recession, two periods of recession separated by a brief upturn. Others were worried the Fed's comments pointed to a soft economic recovery.

The U.S. central bank's Federal Open Market Committee voted unanimously to leave its trendsetting federal funds rate at a four-decade low of 1.75 percent. The FOMC said, however, that the economy was in danger of greater deterioration ahead -- a shift in stance that signals policymakers are prepared to cut rates in coming months should the outlook worsen.

Policymakers noted weak financial markets and problems in corporate reporting in shifting its stance.

Since abandoning a similar warning of the potential for softness in March, policymakers have maintained that threats to the economy were balanced between greater weakness and a pickup in growth that could spark inflation.

But economic growth slowed sharply in the second quarter, with gross domestic product advancing only at an anemic 1.1 percent annual rate after surging at a 5 percent pace in the first quarter. Business investment has been lackluster and new hiring was weak in July, leading many analysts to forecast the Fed will reduce rates between now and the end of the year to try to stimulate activity.

A softening in consumer and business demand that emerged this spring "has been prolonged in large measure by weakness in financial markets and heightened uncertainty related to problems in corporate reporting and governance," the Fed said.

For now, Federal Reserve Chair Alan Greenspan and his FOMC colleagues opted to hold the federal funds rate - the interest that banks charge each other on overnight loans - at 1.75 percent, the lowest level in four decades. It marked the fifth consecutive Fed meeting this year that policy-makers opted to leave rates alone.

However, the Fed changed the wording of its announcement Tuesday, saying that the greatest risk looking ahead is a further slowing of the economy, raising the odds of later rate cuts.

"The risks are weighted mainly toward conditions that may generate economic weakness," the Fed said.

Since its March meeting, the central bank's announcement indicated that economic risks were equally balanced between inflation and possible weak growth, a "neutral" policy stance.

The Fed's decision to hold the funds rate steady means that commercial banks' prime lending rate — a benchmark for many consumer and business loans — will remain at 4.75 percent, the lowest level since November 1965.

The Fed said that low rates "should be sufficient to foster an improving business climate over time."

After bolting out of the starting blocks at the beginning of the year, the economy lost momentum in the spring, growing at a rate of just 1.1 percent in the second quarter. That's down from the brisk 5 percent pace seen in the first three months of this year.

And key economic reports suggest that the second half of the year is getting off to a disappointing start.

Manufacturing — hardest hit by last year's recession — slowed down considerably in July. Consumers' confidence in the economy sank again in July, reflecting worries about jobs, the wave of accounting scandals and the stock market decline. And, companies, unsure of the recovery's staying power, added a paltry 6,000 jobs last month, keeping the nation's unemployment rate stuck at 5.9 percent.