FINANCIAL MARKETS : Stocks, Bonds Rally on Fed Action

From Times Staff and Wire Services

The Federal Reserve Board gave Wall Street what it expected on Tuesday, and investors responded with a collective sigh of relief.

The nation’s central bank raised short-term interest rates by a half-percentage-point, but also said that this fifth credit-tightening move of 1994 will be the last, “at least for a time.”

The Fed’s mid-day announcement sparked a steep decline in long-term bond yields, while sending the Dow Jones industrial stock average up 24.28 points to 3,784.57 in heavy trading.

Early today, Asian stock markets also responded positively to the Fed’s move. Hong Kong’s Hang Seng index was up 133.78 points to 9,500.40 in mid-morning, while Tokyo’s Nikkei-225 index added 47.41 points to 20,833.77.


In Australia, Sydney stocks also were higher as that country’s central bank followed the Fed today, raising short-term rates for the first time since 1989.

In the U.S. bond market, the bellwether 30-year Treasury bond yield tumbled to a two-month low of 7.36% Tuesday from Monday’s 7.50%. Shorter-term yields either were sharply lower or barely changed.

Traders noted that the Fed’s decision to raise two key short-term interest rates satisfied several different groups of investors, thus prompting buying.

For example, investors who want the economy to slow believe the Fed was aggressive enough with its half-point boost to do the job. So inflation expectations were lessened, thus encouraging buyers of long-term bonds.


Investors in shorter-term bonds, meanwhile, were happy that the Fed signaled that this rate boost may be the last for a time, which implies stability in shorter-term yields.

Stock investors were encouraged by bonds’ rally and also by the potential for tighter credit to guarantee a longer, albeit slower, U.S. economic expansion.

“What people have concluded is that what the Fed has done is positive for bonds and stocks,” said Abby Cohen, market strategist at Goldman, Sachs & Co.

“As a bond investor, I’m pretty pleased,” said Dave Rose, chief executive at Alaska Permanent Capital Management, an Anchorage-based firm with $500 million in bonds. The Fed’s action is “a strong enough dose to calm (investors) down,” he said.


Rose said long-term T-bond yields could drop to 6.75% by year’s end, as investors lose their inflation jitters and re-enter the market.

Bond investors also were enthused Tuesday as crude oil prices fell to a two-month low, on news of ample supplies in inventory. Energy prices are key determinants of inflation trends.

September crude futures on the New York Merc slumped 47 cents to $17.73 a barrel.

On Wall Street, the Dow was hovering nearly unchanged at about 1:15 p.m., when the much-anticipated message came: the Fed raised its discount rate from 3.5% to 4% and the federal funds rate--the overnight loan rate among banks--from 4.25% to 4.75%.


The news sent the Dow shooting up 20 points, but it quickly fell back as computerized “sell” programs kicked in. As trading wore on the programs ceased and buyers returned.

In the broad market, winners topped losers by 13 to 9 on the New York Stock Exchange, where volume was 305 million shares, the highest since mid-July.

While stocks were reasonably strong, some traders noted that the markets’ reaction was less pronounced this time than on May 17--the last time the Fed raised rates. That rate hike, also a half-point, was greeted with a 49.11-point Dow surge and a 0.18-percentage point decline in 30-year T-bond yields, to 7.26%.

In the May 17 announcement, the Fed also suggested it was finished tightening credit, at least temporarily. But within a month healthy statistics on the economy began to focus investors on the potential for another rate boost, and stocks tumbled while long-term bond yields shot up again.


Marshall Acuff, strategist at brokerage Smith Barney in New York, warned that despite Tuesday’s rally stocks may have a hard time in the months ahead.

Acuff said that by October or November the stock and bond markets could again be wrestling with the potential for another Fed rate hike, unless the economy slows appreciably.

Among Tuesday’s highlights:

* Drug stocks continued to lead the market. Merck jumped 3/4 to 33 7/8 after saying it will sell its chemical divisions to focus on its main drug business.


Other drug stocks gained on new takeover talk. Bristol-Myers surged 1 7/8 to 57 1/4, Lilly rose 1 1/2 to 54 1/2, Pfizer leaped 1 3/8 to 66 3/4 and Schering-Plough rose 1 3/8 to 71 3/8.

* Other classic growth stocks also rallied. Investors often turn to these predictable-growth shares when they expect the economy to slow, jeopardizing earnings growth of industrial companies.

Among retailers, Home Depot jumped 2 3/8 to 44 3/8 after posting strong second-quarter earnings.

Earnings reports also boosted Dayton-Hudson 1 3/4 to 85 1/4, Toys R Us 2 to 35 3/4 and Wal-Mart 1/2 to 24 1/4. But J.C. Penney dropped 1 3/4 to 47 1/8 on its report.


* Among other growth issues, Pepsico gained 1 1/4 to 32 3/8 after saying it will resume its share-buyback program. Rival Coca-Cola jumped 1 3/8 to 45 5/8.

* Among technology shares, Hewlett-Packard rocketed 8 1/2 to 87 5/8 after posting sharply higher earnings. Other tech issues gaining included Texas Instruments, up 1 3/8 to 84 5/8, Autodesk, up 1 3/4 to 51 1/2, and Compaq, up 1 1/2 to 36 5/8.

* Many industrial issues rose despite concerns about a slower economy. GM gained 1 1/8 to 51, Cummins Engine added 1 to 39 3/4 and Scott Paper was up 1 1/4 to 63 3/8.

In foreign markets, Mexico City’s Bolsa index jumped again, helped by a bullish report on second-quarter economic growth. The Bolsa rose 43.10 points to 2,694.60, highest since Feb. 21.


In Tokyo on Tuesday, the Nikkei rose 160.03 points to 20,786.36. Frankfurt’s DAX average added 4.30 points to 2,143.14 and London’s FTSE-100 index was up 5.2 points to 3,147.4.