Bonds Rally on Fed Stance; Stocks Climb

Treasury bond yields slumped and stocks closed mostly higher Tuesday after the Federal Reserve signaled it could drop interest rates again if conditions warrant.

The central bank kept its key short-term interest rate at 1.25%, as expected. But Fed policymakers issued a surprising warning about the risk of deflation, and indicated they could lower the cost of credit if necessary to fight deflation.

The news encouraged some investors to pile into Treasury bonds, betting that the long rally in those securities could continue. The yield on the two-year T-note slid from 1.53% on Monday to 1.42%, the lowest finish since March 11.

The yield on the 10-year T-note, a benchmark for mortgage rates, fell from 3.89% on Monday to 3.78%, the lowest closing level since March 14. The yield still is above the generational low of 3.56% reached on March 10.

In the stock market the Fed’s statement at midday initially was a jolt, interrupting a broad rally. After a brief sell-off the market resumed its climb, sold off again, then rebounded in late trading.

The Dow Jones industrial average, which was up as much as 110 points at its peak, closed with a gain of 56.79 points, or 0.7%, at 8,588.36.

The Standard & Poor’s 500 index added 7.84 points, or 0.9%, to 934.39, its highest closing level since Dec. 2.

The technology-dominated Nasdaq composite index continued to pace the market’s advance, rising 19.67 points, or 1.3%, to 1,523.71, its highest close since June 18.

Analysts generally weren’t surprised that Treasury bond yields declined on the Fed’s statement. But they said stock investors could have viewed the central bank’s warning about deflation as a sign that policymakers don’t believe the economy is poised to rebound in the second half of the year.

Without a rebound, corporate earnings could be disappointing, undermining share prices, some experts said.

“The best scenario for investors would be positive statements that the economy is picking up, investment is picking up, and risks are toward the upside with a possible rate increase,” said Arnie Holzer, senior investment strategist for Deutsche Asset Management Americas. “But clearly we’re not at that level yet.”

Even so, Wall Street kept a generally upbeat attitude: Rising stocks outnumbered losers by 2 to 1 on the New York Stock Exchange and by 19 to 13 on Nasdaq, in active trading.

Still, given the strong advance in stocks since mid-March, fresh pessimism about the economy could quickly trigger profit-taking, some analysts warn.

“We’re already pricing in an improving economic situation,” Jonathan Golub, a money manager at J.P. Morgan Fleming Asset Management, told Bloomberg News. “In the latter part of the year, if we don’t see improvement, the market is going to sell off.”

Among Tuesday’s highlights:

* The Treasury bond market rallied even as the government sold $22 billion in three-year notes amid what some traders said was just moderate demand. The notes sold at a yield of 2.01%.

* Financial services stocks may have been helped by expectations of lower interest rates. Merrill Lynch rose 97 cents to $42.29, Citigroup added 42 cents to $39.95 and Countrywide Financial surged $1.07 to $68.58.

* Home Depot gained 56 cents to $29.48 after brokerage Goldman Sachs raised its rating on the stock to “outperform” from “in line.”

* Telecom and media stocks helped fuel Nasdaq’s advance. Copper Mountain Networks jumped $1.45 to $7.95, EchoStar Communications rose $1.54 to $32.17 and Pegasus Communications rocketed $3.73 to $32.35.

* Personal computer stocks also were strong, led by Dell Computer, up $1.01 to $30.51, and Apple Computer, up $1.41 to $17.50. In the semiconductor sector, Intel was up 52 cents to $19.54.

* Marvel Enterprises gained $1.52 to $19.82 after the comic book publisher forecast a jump in profit this quarter, as movie studios license more of its superhero characters.

Market Roundup, C6-7