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Stocks Fall on Inflation Warning

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Times Staff Writer

Stock and bond markets fell sharply Tuesday after the Federal Reserve warned of growing inflation pressures -- raising the risk that the central bank might begin to tighten credit more aggressively.

Stocks in rate-sensitive industries such as home building and financial services retreated quickly after the Fed said inflationary pressures “have picked up in recent months.”

The language overshadowed the seventh straight boost in the federal funds rate -- to 2.75% from 2.5% -- which had been expected.

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The Dow Jones industrial average sank 94.88 points, or 0.9%, to 10,470.51. The Dow had been up almost 40 points before the Fed announcement.

The Nasdaq composite skidded below 2,000, falling 18.17 points, or 0.9%, to 1,989.34, its lowest level since Nov. 2. The Standard & Poor’s 500 backtracked 1%, shedding 12.07 points to 1,171.71.

The market sell-off came in spite of a substantial drop in crude oil prices. Oil fell $1.43 a barrel to $56.03 in New York futures trading.

Some analysts say Wall Street’s slide could continue in the days ahead as investors focus more on the Fed’s warning and what it could mean for interest rates in general.

“I don’t think we’re at the point yet where investors are concerned enough about the downside risks in the financial markets due to inflationary pressures,” said Tom McManus, chief investment strategist at Banc of America Securities in New York.

The bond market was hit especially hard because inflation diminishes the value of fixed-income payments. The yield on the benchmark 10-year Treasury bond jumped to 4.63% from 4.52% on Monday and now is the highest since late June. Falling bond prices push their yields higher.

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Stocks can be hurt two ways by rising interest rates, said Hugh Johnson, chief investment officer at Johnson Illington Advisors in Albany, N.Y.

For one thing, higher yields attract investors, some of whom sell stocks to buy bonds, he said. Rate hikes also increase corporate borrowing costs and, thus, slice into company earnings.

Nevertheless, some analysts said investors overreacted Tuesday, pointing to the Fed’s statement that corporate “pricing power is more evident.”

That’s welcome news for companies that have been unable to make price hikes stick in recent years.

“The basic business condition is really good,” said Bob Bissell, president of Wells Capital Management. “But it’s hard for investors to not worry about the Fed.”

While the stock and bond markets struggled, the dollar rose to one-month highs against the euro and the Japanese yen. Higher interest rates could attract more foreign investment into the United States, lifting the buck. The euro fell to $1.307 from $1.317 on Monday. The greenback bought 105.57 yen, up from 105.04.

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In other market highlights:

* Financial shares, which often suffer during periods of rising rates, got clobbered. Citigroup slid $1.32 to $44.44, J.P. Morgan Chase lost 73 cents to $35.06, Bear Stearns retreated $2.29 to $99.58, Wells Fargo slipped 81 cents to $58.38 and Chubb was down $2.29 to $75.51.

* Home builders were up early in the session on strong earnings reports from KB Home and Lennar. They reversed course after the Fed statement. Ryland Group, which hit a high of $66.41 on Tuesday morning, fell back to $64.27 for a 6-cent gain. Los Angeles-based KB Home ended at $118.60, up $1.90, after trading as high as $121.70. Lennar gained 73 cents to $55.60 after hitting $58.06 earlier.

* Microsoft fell 21 cents to $23.99, a 52-week low. Other technology companies retreated, dragging down Nasdaq. Intel fell 48 cents to $23.02 and Advanced Micro Devices sank 37 cents to $15.38. Apple Computer slid 87 cents to $42.83.

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Rate outlook

Here’s a look at where some key interest rates stand and the outlook in the wake of the Federal Reserve’s latest interest-rate increase:

* Prime lending rate:

5.75% (current rate)

Major banks raised the prime a quarter of a point Tuesday, to 5.75%, matching the Fed’s increase. The prime, a benchmark for many consumer loans, usually changes in tandem with Fed shifts.

* Money market mutual fund average yield (seven-day): 1.98%

Money fund yields usually track Fed rate changes, with a lag of six to eight weeks. The average fund yield has risen 0.23 point since the Fed’s last rate hike Feb. 2.

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* Six-month CD yield

(U.S. average): 2.00%

Certificate of deposit yields have been rising at a steady pace since last summer, as the Fed has raised its key rate. They are expected to continue to rise.

* 10-year Treasury note yield: 4.63%

Long-term bond yields have surged in recent weeks, in part reflecting inflation concerns stemming from rising oil prices. The 10-year T-note is up from 4.22% at the start of the year. The Fed doesn’t control long-term rates; rather, they are set by the marketplace. If investors believe inflation will rise they are likely to demand higher bond yields to compensate. But if investors believe that the Fed’s credit-

tightening policy will cool the economy and inflation, they may expect that the next big move in bond yields would be down.

* 30-year mortgage rate

(Freddie Mac average): 5.95%

Mortgage rates generally follow bond yields. With the latest rise in bond yields, mortgages are likely to top 6% soon.

Graphics reporting by Tom Petruno

Sources: Informa Research Services, ImoneyNet Inc., Bloomberg News

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