Inflation Drop Fuels Bond Rally and Sends Dow to New Record

News of an unexpected August decline in wholesale prices sent bond yields plunging on Tuesday, powering the Dow Jones industrial average to its first record close since mid-July.

In currency trading the dollar roared ahead, ending above 100 yen in New York and trading at 101.65 yen by midday today in Tokyo.

On Wall Street the Dow jumped 42.27 points to a record 4,747.21, finally topping the old high of 4,736.29 set July 17.

The Dow had struggled in late July and early August even though broader stock indexes were hitting new highs. The blue-chip Dow companies’ image was hurt in part by the rising dollar, which threatens to crimp earnings of multinational firms.

But enthusiasm over the latest slide in interest rates is overcoming worries about the resurgent dollar, analysts say, pulling investors back into blue-chip names.

The August inflation report, coming on the heels of Japan’s surprise interest-rate cut last Friday, convinced more investors that the Federal Reserve Board will be able to further reduce U.S. short-term rates. Rate cuts are almost always bullish for stocks.

“The Fed has been gearing interest-rate policy [to] inflation, along with economic growth,” said Tony Dywer, chief market strategist at Josephthal Lyon & Ross. With inflation subdued and economic growth modest, “the Fed has leeway” to cut rates, he said.

In the bond market the yield on the benchmark 30-year Treasury bond fell from 6.59% on Monday to 6.50%, the lowest since the yield hit 6.49% on July 6. The 1995 low yield for the bond was 6.47% on June 22.

Shorter-term yields also tumbled on Tuesday. The two-year T-note yield fell to 5.76% from 5.83% on Monday.

The bond market faces another inflation report today, when the government reports on August consumer prices.

If inflation remains contained long-term T-bond yields could drop to 6.25% by the end of the year, said John Burgess, a bond fund manager at Bankers Trust New York Corp.

The dollar’s ongoing advance against the yen could help stoke the bond rally, experts say. As the dollar rises Japanese investors will be more encouraged to buy U.S. bonds, which already sport much more lucrative yields than Japanese issues.

And if more Japanese capital flows into U.S. securities, it may make an even stronger dollar--and weaker yen--a self-fulfilling prophecy.

The dollar jumped to 101.10 yen in New York on Tuesday from 99.98 on Monday. Today in Tokyo the dollar hit 101.65 yen, topping its previous 1995 high of 101.45 set in January.

Tokyo traders reported today that Japanese investors were piling into foreign bonds.

The Japanese also may be helping fuel the Dow’s rebound, experts note, because they would get the same currency-translation benefit of a stronger dollar in U.S. stocks as in bonds. And foreign investors are more likely to chase “brand-name” blue-chip names than unknown smaller stocks.

Indeed, smaller stocks lagged on Tuesday: The Russell 2,000 index of smaller issues reached a record high but advanced just 0.2% versus the Dow’s 0.9% jump.

And the red-hot Nasdaq composite index closed slightly lower, off 1.56 points to 1,065.00 as technology stocks took a breather.

Still, winners topped losers by 14 to 9 on the NYSE and by 18 to 16 on Nasdaq in active trading.

Among Tuesday’s highlights:

* The Dow was led by Eastman Kodak, up 1 3/8 to 50 1/8; Exxon, up 1 1/8 to 72 5/8; GE, up 1 1/8 to 60; Disney, up 1 1/8 to 56 3/8; and J.P. Morgan, up 1 5/8 to 74 3/4.

* Many financial issues rocketed with the latest slide in bond yields. SunAmerica jumped 1 1/2 to 60 3/8, Chubb soared 1 7/8 to 92 3/4, Merrill Lynch gained 1 1/4 to 61 3/8 and Imperial Credit leaped 1 7/8 to 27 3/4.

* On the down side, auto stocks fell as news of planned autumn production cuts sparked earnings concerns. GM slumped 1 5/8 to 47 3/4, Ford fell 1 1/8 to 30 7/8 and Chrysler lost 3/4 to 56 5/8.

Also, two suppliers to the auto industry were slammed after both forecast lower near-term earnings. Inland Steel sank 2 3/8 to 26 1/8 and chemical firm Ferro dropped 2 1/4 to 24 7/8.

In foreign trading, London’s FTSE-100 index eased 13.4 points to 3,535.9 and Tokyo’s 225-share Nikkei average slipped 13.94 to 18,472.17.

In commodities trading, surprisingly low government estimates of American wheat, corn and cotton production set off sharp rallies in those commodities.

* AUGUST DEFLATION

Wholesale prices fall. D2