Stocks Rally on Weak GDP Data

Stocks rose and bond yields fell sharply Friday as mounting evidence of an economic slowdown stirred new hopes that the Federal Reserve would stop raising interest rates.

The yield on the 10-year Treasury note, a benchmark for mortgages, slid below the psychologically important 5% level after the government said the economy expanded at a slower-than-expected 2.5% annualized pace in the second quarter.

The gross domestic product report provided a strong case for Fed policymakers to halt their 2-year-old credit-tightening campaign, many analysts said. That could mean that the Fed will take a pass at its next meeting Aug. 8.

Stocks rallied broadly on that possibility, with the Dow Jones industrial average climbing 119.27 points, or 1.1%, to 11,219.70, its highest since July 6.

The Nasdaq composite index jumped 39.67 points, or 1.9%, to 2,094.14.

The market’s gains were relatively restrained compared with recent rallies. That suggested that some investors remain cautious about stocks, worried that the economy might slow too much.

Wall Street has fretted since mid-May that the Fed’s efforts to quash inflationary pressures with higher interest rates could snuff out economic growth and hammer corporate earnings.

Money managers are split on whether the economy will turn fallow or achieve a so-called soft landing.

“There’s a lot of confusion about whether times will be good or bad,” said Robert Bissell, president of Wells Capital Management in Los Angeles.

For the Treasury bond market, good times would mean a weak economy that would open the door to Fed rate cuts down the road.

Investors jumped into bonds Friday on the expectation that interest rates might have peaked. The 10-year T-note yield ended at 4.99%, down from 5.04% on Thursday. The yield hit 5.24% on June 28, its highest since 2002.

“If bond traders can ever be happy, I suppose today was the day,” said Sharon Lee Stark, fixed-income strategist at Stifel Nicolaus & Co. in Baltimore.

The yield on the two-year Treasury note dropped to 4.98% from 5.05% on Thursday. The yield now is the lowest since June 5 and is down from a peak of 5.28% on June 28.

Rising interest rates, combined with the volatile stock market, have driven many individual investors into money-market funds and other short-term accounts this year. The average annualized yield on money market funds is 4.78%, according to fund tracker ImoneyNet Inc.

But if interest rates are peaking, investors might want to shift some money into longer-term bonds, Stark said.

“If I were an individual investor, I would certainly start locking in some long-term yields,” she said.

One risk, however, is that inflationary pressures still appear to be building, in part because of higher oil prices. In the GDP report Friday, one closely watched index of core inflation -- price changes outside the food and energy sectors -- rose at a 2.9% annual rate in the quarter, the fastest pace since 1994.

Inflation is the worst enemy of bond owners because it erodes fixed-rate returns.

But for now, the bond market “is willing to look past the inflation story” and believes that a slowing economy will constrain price increases, said David Ader, government bond strategist at RBS Greenwich Capital Markets in Greenwich, Conn.

As for the stock market, Bissell said he believed that the prospects for stocks were bright, because “you have a powerful and diverse economy, which could grow at a slower rate but still an impressive” one.

Many market bulls point to generally upbeat second-quarter earnings reports.

Earnings-tracker Reuters Estimates said the expected growth rate for second-quarter operating earnings of the Standard & Poor’s 500 companies was 11.7%, an increase from 10.7% a week earlier because of some robust profit reports this week.

Among the day’s market highlights:

* Winners topped losers by 4 to 1 on the New York Stock Exchange and by more than 2 to 1 on Nasdaq, although in slower trading than on Thursday.

* The S&P; 500 index rose 15.35 points, or 1.2%, to 1,278.55. The Russell 2,000 small-stock index gained 2.1%.

* For the week, the Dow was up 3.2%, its best weekly gain since May 2005. The S&P; 500 rose 3.1% for the five days, the Nasdaq index gained 3.6% and the Russell 2,000 rose 4.2%.