Stocks Mixed on Rate News; Treasury’s Plan Rallies Bonds
Federal Reserve Chairman Alan Greenspan decided to go easy on Wall Street on Wednesday.
Or did he?
The Fed raised its key short-term interest rate a quarter point, to 5.75%--a relief to investors who feared the central bank would order a half-point boost. But the Fed’s moderate approach just makes for greater uncertainty over what’s next for rates, some analysts warned.
After an initial burst of selling after the Fed’s announcement at about 11:15 a.m. Pacific time, stocks resurged, only to sell off again late in the day. By the close, most key indexes were little changed. The Dow industrials slipped 37.85 points to 11,003.20. The Nasdaq composite rose 21.98 points to 4,073.96.
In the bond market, meanwhile, yields ended mostly lower. But rather than paint that as a relief rally, many bond pros said the market’s action in large part reflected the Treasury Department’s announcement that it will sell less new debt than expected next week, and will soon begin buying back longer-term securities.
The 30-year T-bond yield tumbled to 6.29% from 6.43%, the biggest rally in five months. The yield peaked on Jan. 20 at 6.75%.
But yields on shorter-term Treasury securities, some of which have hit five-year highs in recent days on worries about the Fed, declined less sharply Wednesday.
The two-year T-note yield actually inched up to 6.60%, from 6.58% on Tuesday.
The problem now for both the stock and bond markets, analysts say, is that the Fed’s modest rate increase Wednesday just boosts uncertainty about how high the central bank might eventually go.
Memories loom of 1994, when the Fed opened its credit-tightening campaign with three hikes of a quarter-point each in February, March and April of that year, then escalated to two half-point hikes, a three-quarter-point hike (in November) and then a final half-point increase in early 1995.
By the time the Fed was done, the federal funds rate--the overnight loan rate among banks--had been lifted a full three percentage points in less than 12 months, from 3% to 6%.
That made for one of the worst years in memory for bonds, as yields soared, devaluing older bonds paying lower rates.
This time, with the fed funds rate already at 5.75%, most experts don’t believe the Fed will have to double rates from these levels to slow the economy.
Still, a go-slow Fed moving at a quarter-point pace leaves investors guessing about how many more rate increases are ahead, and over what period of time.
The Fed’s official statement Wednesday said the central bank believes the risks are “weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future.”
Many Wall Streeters believe that will mean at least two more quarter-point rate increases this year. Others, however, say rates may well be peaking now, assuming the economy slows and inflation remains subdued.
Uncertainty is part of the point, said Dan Laufenberg, chief U.S. economist for American Express. If the Fed’s goal is to slow the economy, it must push up long-term rates because the instruments that drive economic growth--mortgages and corporate bonds, in particular--are long-term ones, Laufenberg said.
Paradoxically, a half-point or even three-quarter-point rate hike by the Fed could give the markets the impression that the central bank is doing all its tightening in one swipe--which could spark a true relief rally in bonds that would bring long-term rates down sharply, he said.
That could defeat the Fed’s purpose in trying to tighten credit, and start a new borrowing and spending binge.
“The only way to do it is to make it slow and drawn out and maybe more painful for the markets than people hoped,” Laufenberg added.
He and many other bond analysts believe that most longer-term interest rates likely will rise until there is persuasive evidence that the economy is slowing.
That, of course, would put pressure on the housing market, where 30-year mortgage rates already have risen from 6.75% to 8.25% in the last year.
Still, some Wall Streeters doubt that the Fed is consciously using psychological warfare by tightening in small increments.
“If there had been a very compelling case for 50 basis points [a half-point rate hike], they would have done it,” said economist Robert V. DiClemente at Salomon Smith Barney.
As the large interest rate hikes of 1994 demonstrated, Greenspan has shown himself to be fully capable of abandoning gradualism and “turning up the heat when he needs to,” he said.
“If it turns out the markets conclude this is somehow water torture, that in turn becomes part of the outlook that the Fed considers” in its future deliberations, DiClemente added.
The stunning rally among high-tech stocks over the last few months has obscured the fact that the broader stock market has long been feeling the dampening effect of rising interest rates.
The New York Stock Exchange composite index is down more than 3% from June 30--the date of the Fed’s first rate hike in this cycle.
Thus, the stock market overall isn’t “putting any new fuel in the tank” for more rapid economic growth and therefore shouldn’t be a big factor in the Fed’s thinking, according to DiClemente.
Phil Schettewi, head of the equity group at Prudential Investments, said that the latest quarter-point rate hike in itself “doesn’t put any crimp in the profit picture” for most corporations and thus should not cause any additional damage to the stock market.
Some analysts view the three individual quarter-point increases that came before Wednesday’s move as an “unwinding” of the three quick rate cuts that the Fed made in the fall of 1998 in response to the international financial crisis brought on by the Russian bond default and the collapse of the Long-Term Capital hedge fund.
If so, one can view Wednesday’s hike as the first in a new tightening series, said Michael Cloherty, bond strategist at CS First Boston.
Again, as in 1994, the Fed likes to kick things off with a quarter-point increase to signal its intentions and then follow up with bigger hikes as necessary, Cloherty said.
“The Fed would be happy if the market would do some of its work for it [by raising long-term rates further], but lately it’s been going the other way,” he said, referring to the recent rally in 30-year Treasury bonds. If that rally continues, and spreads to other long-term yields, he said, “it might force the Fed to be more aggressive.”
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Market Roundup, C9
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The Fed Moves Again
Federal Reserve policymakers on Wednesday raised their key short-term interest rate, the federal funds rate, from 5.5% to 5.75%--the highest since July 1995. That will put fresh upward pressure on other short-term interest rates. But the effect on longer-term rates, and on stocks, will depend on other factors as well.
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Source: IBC Financial Data; Times research
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The Fed and the Stock Market
The Federal Reserve doesn’t say so, but many analysts believe that a key goal in raising interest rates is to slow the stock market as well as the economy. And in fact, most major market indexes have made modest progress, or have declined, since the Fed’s first rate increase last June 30. The technology-heavy Nasdaq composite index is the exception. How key indexes have fared since June 30:
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Close on Wed. Pctg. Index June 30 close change Nasdaq composite 2,686.12 4,073.96 +51.7% S&P; mid-cap 416.70 441.01 +5.8 S&P; small-cap 185.52 196.35 +5.8 S&P; 500 1,372.71 1,409.12 +2.7 Dow industrials 10,970.80 11,003.20 +0.3 Dow utilities 316.82 311.41 --1.7 NYSE composite 648.13 625.93 --3.4 Dow transports 3,404.36 2,609.66 --23.3
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Source: Times research
RATE BOOST
The Fed hiked key short-term interest rates a quarter-point. A1
