Overseas Markets Crash, Fed Cuts 75, Markets Gap Down At The Open And Reverse

Markets sold off badly overseas on Monday as investors feared the effects of a US recession on the rest of the world (Overseas Selloff Graphic).

As a consequence, US futures markets were in panic mode yesterday ahead of today’s opening.

With US stock markets set to open lower the Fed decided it was time to act and made 75 basis point cuts to both the Fed Funds rate and the Discount rate before the open this morning (FOMC Statement Jan 22 2008).

This is no accident but rather a direct response to the massive selling in asset markets as Bernanke knows that markets only respond to surprise moves by the Fed, as documented in a 2004 paper of his that is circulating widely today.

Nevertheless, US stock markets gapped massively lower at the open with the Dow down 450 points, the S&P 50 points and the Nasdaq 120 points in the first 15 minutes.

The Volatility Index (VIX) gapped up 9 points, 33%, to 36 (VIX 1 Day Chart) – right around the peak levels we saw on Thursday August 16th.

However, in a potential sign of a short term bottom, buyers stepped in and we’ve seen a bit of an intraday reversal.  The VIX has come down quite a bit as well to around 31.

Today’s action reminds me a lot of August 16-17.  I remember going to bed late on Thursday night, August 16th, noting that, despite the late day reversal rally in US stocks, overseas markets had sold off badly on Friday.  Bernanke stepped in the next morning with a 50 point cut to the discount rate and a suggestion that cuts to the Fed Funds rate could be coming.  Market soared.

At the same time, we’re 5 months down the road and expectations of a recession and a consequently longer term bear market are much more widely spread.  That suggests that any bounce, which I expect, will likely be more short lived than the Aug 17 – Oct 11 move we saw last Fall.