Inflation fears rise with stocks
The stock market Wednesday extended its celebration of the Federal Reserve’s interest rate cut as a sure tonic for the economy, but amid the hoopla was concern that the intended cure could unleash a bout of inflation.
With the half-point cut Tuesday in its key short-term rate, the Fed showed its determination to prevent the sub-prime mortgage crisis and resulting credit crunch from derailing the economy. And there were signs that the move was succeeding in making it easier to borrow.
But even some who applauded the Fed’s action acknowledged that higher consumer prices could be the trade-off. Those fears may have played out in the government bond market, where interest rates on long-term Treasury securities jumped for a second day Wednesday instead of falling, as normally would be expected after a Fed rate cut.
The yield on the 30-year Treasury bond climbed to 4.84% from 4.76% late Tuesday. The yield on the 10-year Treasury note, which influences home-mortgage rates, rose to 4.54% from 4.47%.
“The bond market is scared to death of inflation,” said James Bianco, president of Bianco Research in Chicago.
But some riskier bonds, including junk-rated corporate debt, rallied on the belief that a vibrant economy makes lending money less risky. The average yield on an index of junk bonds tumbled Wednesday to 8.02%, down from 8.14% on Tuesday. That was its lowest level since July 19.
And several large companies jumped at the opportunity to borrow billions of dollars on terms that had suddenly improved.
The stock market, which soared Tuesday in response to the rate cut, climbed again, with the Dow Jones industrial average gaining 76.17 points, or 0.6%, to 13,815.36, bringing its two-day gain to 3.1%. The index is within 185 points of the all-time high it set July 19.
Broader stock indicators also advanced Wednesday. The Standard & Poor’s 500 index rose 9.25 points, or 0.6%, to 1,529.03. The Nasdaq composite index gained 14.82, or 0.6%, to close at 2,666.48.
All 10 industry groups in the S&P; 500 gained for a second day, and advancing issues outnumbered decliners by about 2 to 1 on the New York Stock Exchange, where trading volume topped Tuesday’s level.
Overseas, share prices soared Wednesday in their first response to the Fed’s move. Key indexes surged 2.8% in Britain, 2.3% in Germany, 3.3% in France, 3.7% in Japan and 4% in Hong Kong.
In the U.S., the stock market was buoyed by the Fed’s reassuring statement that it “will act as needed” to protect the economy, analysts said.
The central bank “stepped in with a very strong action, and that’s given people confidence to go back in and start taking risk,” said Dan Shackelford, a bond fund manager at T. Rowe Price, who said the rise in Treasury yields wasn’t just about inflation.
Investors had huddled into government bonds as a safe haven when the financial markets capsized in July and August. That pushed their yields down. (A bond’s yield and price move in opposite directions.)
With investors now less risk-averse, some have been selling Treasuries to buy stocks and corporate bonds, Shackelford said.
The markets also benefited Wednesday from data depicting inflation as contained.
The Labor Department reported that consumer prices fell 0.1% in August and that so-called core prices, which exclude volatile food and energy costs, were up only 2.1% from a year earlier.
But some bond investors believe warning signs of inflation pressures, including resurgent commodity prices, are already in place and will be exacerbated by the economic boost provided by the rate cut.
In part because of the potential for increased demand from a stronger U.S. economy, oil prices closed Wednesday at a record for the seventh time in eight sessions.
The price of gold, a traditional hedge against inflation, jumped Wednesday to a level approaching its 27-year intraday high set Tuesday.
“We tend to be a very stock-market-focused world,” Bianco said. “The Fed cuts rates and the stock market goes up 335 points and [people think] there are no problems in the world. It doesn’t matter that gold hit a 27-year high or that all these other markets are having these problems.”
By boosting investor confidence, the rate cut will help to alleviate the credit crunch and slowly help Wall Street investment banks sell takeover-related debt they have been stuck holding, said Brian Wesbury, chief economist at First Trust Advisors in Lisle, Ill.
“It allows [investors] to take a risk that they wouldn’t have taken if the Fed had not cut,” Wesbury said. “But it comes at a price, and that price is higher inflation.”
In other market highlights:
* The dollar rose from an all-time low against the euro. The U.S. currency also gained versus the yen.
* The Russell 2,000 index of smaller companies made a big advance again Wednesday, rising 10.77 points, or 1.3%, to 817.40. Small-cap stocks had taken a hit in Wall Street’s recent retrenchment as investors regarded bigger companies as better able to weather an economic downturn.
* Morgan Stanley dropped $1.48, or 2.2%, to $67.03 after the No. 2 U.S. investment bank said its third-quarter profit sank 17% as it was forced to write down nearly $1 billion in loans because of credit market dislocations. Shares of Bear Stearns, which is due to report results today, slid $3.56, or 3%, to $115.64. But Goldman Sachs gained $5, or 2.5%, to $205.50.
* The regulator of Fannie Mae and Freddie Mac said it would let the government-chartered companies expand their home-loan portfolios, a move expected to improve the market for mortgage securities. Fannie Mae rose $1.44, or 2.3%, to $63.98. Freddie Mac climbed $1.64, or 2.8%, to $61.16.
* Shares of mortgage lender Countrywide Financial rose 66 cents, or 3.3%, to $20.54 on upbeat remarks late Tuesday by the Calabasas-based company’s chief executive, Angelo Mozilo.
* Bond insurer MBIA rose $2.52, or 4.1%, to $64.16. Rival Ambac Financial Group gained $3.60, or 5.5%, to $68.85.
* Freeport-McMoRan Copper & Gold rallied $2.20, or 2.1%, to a record $105.50 as copper prices rose to a six-week high on speculation the Fed’s rate cut will boost demand for metals.
CarMax sank $3.77, or 15%, to $21.29. The auto retailer missed analysts’ expectations for sales in the second quarter and cut its profit target for the year.
* Warnaco Group jumped $5.41, or 15%, to $41.58 after saying it would sell most of its swimwear brands.
--
Times wire services were used in compiling this report.
