Markets rebound following Fed talk

WEDNESDAY, AUG. 10, 2011

Interest rates to stay low through middle of 2013

NEW YORK – The Fed spoke – and financial markets rallied.

The Dow Jones industrial average surged more than 429 points, its tenth-highest point gain in history and the biggest since March 2009. It was just one day after the Dow had its worst point decline since 2008.

The Federal Reserve pledged to keep its key interest rate at its record low of nearly zero through the middle of 2013. The central bank also said that it has discussed “the range of policy tools” it can use to spur the economy.

Bob Doll, chief equity strategist at BlackRock, said the Fed’s decision to hold interest rates at a very low rate for two years is “unprecedented” and called it a kind of “backdoor quantitative easing.” In June, the central bank finished a second round of buying Treasury securities, also known as quantitative easing, in hopes of boosting the economy.

“Markets are going to do what they would have done if the Fed went out and bought securities,” Doll said. He said he expects investors will return to stocks after the broad sell-off of the last few weeks.

He expects stocks to continue to rally because a slow-growing U.S. economy won’t harm corporate profits. As a whole, the companies in the Standard & Poor’s 500 index reap more than half their revenue overseas. What’s more, companies have already cut costs significantly, have hoarded cash and squeezed more production out of workers. Even as the U.S. economy has slowed, the S&P 500 as a whole was expected to earn record profits this year.

“Corporate America has demonstrated that it can generate good growth and profits despite a weaker U.S. economy,” Doll said.

The Dow rose 429.92 points, or 4 percent, to 11,239.77. On Monday, the Dow plunged 634.76 points in the first trading day after Standard & Poor’s downgraded the U.S. one notch from its top AAA credit rating to AA+.

The industries that did best on Tuesday were the ones that fell the most on Monday. Financial stocks in the S&P 500 rose 8.2 percent after falling 10 percent Monday. Materials companies, which rely on a stronger global economy for their profits, rose 5.9 percent.

Boosting the stock market isn’t one of the Fed’s jobs, but that hasn’t stopped investors from parsing every word of the statements made by the Fed and its chairman, Ben Bernanke.

The Fed’s mandate is to keep prices stable and promote low unemployment, not boost stocks. But a stock dive after Fed comments has happened before. On June 3, the stock market suffered a late-day dive when Bernanke spoke at a conference. Investors said they were looking for a hint of new plans to spur economic growth. When that didn’t come, all three major indexes sank.

After Bernanke outlined the plan for a second round of quantitative easing in August 2010, the S&P 500 index gained 28 percent over eight months. Investors pointed to that rebound as evidence that quantitative easing worked – and so did Bernanke. This sentiment led some people to believe that if stocks fall too far, the Fed would come to the rescue.

The Fed said in its statement Tuesday that it expects “a somewhat slower pace of recovery over coming quarters.” It had said as recently as six weeks ago that temporary factors, such as the high price of gasoline this spring and Japan’s March earthquake and tsunami, would end and the economy would grow at a faster pace in the second half of the year. But on Tuesday, the Fed said those factors were only part of the reason that the economy grew at its slowest pace in the first half of 2011 since the recession ended in June 2009. It now expects slower growth over the next two years.

Economists now believe there is a greater chance of a U.S. recession because the economy grew much more slowly in the first half of 2011 than previously thought. The manufacturing and services industries barely grew in July. The unemployment rate remains above 9 percent, despite the 154,000 jobs added in the private sector in July.

Economies across the globe are also struggling.

Worries are growing that Spain or Italy could become the next European country to be unable to repay its debt. High inflation in less-developed countries, which have been the world’s main economic engine through the recovery, is another concern.

China’s inflation rose to a 37-month high in July.


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