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Rate Jitters Slam Stocks

Major U.S. indexes slumped for a second straight session as rising labor costs fueled worries of higher interest rates

Is a correction looming for U.S. stocks? Major U.S. indexes stumbled for a second straight session Wednesday on growing concern about inflation -- and interest rates -- in response to a first-quarter productivity report.

Rising prices aren't Wall Street's only worry. Europe provided some fodder for the bears, with another interest rate hike by the European Central Bank sparking big losses in major bourses in London, Paris, and Frankfurt. A very bearish call on European equities form a big brokerage was the icing on the cake.

What should investors be focusing on next? Some observers were looking toward the Thursday trading session in Asia to see if global market jitters will continue.

Investors will closely watch Treasuries, as yields approaching 5% for two- and ten-year notes could lure money away from equities.

Gavin Redknap, an economist at Standard Chartered Bank in London, notes that while global markets have shrugged off the fall in China's equity market over the past week, attention is returning to more mature markets, with interest rate expectations for the Fed as the key area of uncertainty, according to a report from Standard & Poor's MarketScope. Recent data, particularly from the labor market, have prompted the firm to push back its expectation for U.S. rate cuts. In the near term, Redknap expects the Fed "will continue maintaining a moderately hawkish tone."

On Wednesday, the Dow Jones industrial average fell 129.79 points, or 0.96%, to 13,465.67. The broader S&P 500 index, was down 13.57 points, or 0.89%, at 1,517.38.

The tech-heavy Nasdaq Composite index lost 24.05 points, or 0.92%, to 2,587.18.

Tuesday's declines broke a winning streak for the S&P 500 and Dow average, which had closed at record levels for several days in a row. Some analysts have been calling for a natural pullback after the recent gains.

The trading session Wednesday got off to a rocky start after the release of U.S. productivity data. Productivity grew 1% in the first quarter, down from 1.7% reported initially. Labor costs moved up a higher-than-expected 1.8%, from 0.6% previously reported. Productivity and unit labor costs are going the wrong way for policy makers worried about inflation, Action Economics says.

And Fed officials continued to sound warnings on the topic. In comments made Wednesday, Cleveland Fed President Sandra Pianalto said the surge in commodity prices was testing the board's inflation fighting mettle.

A bearish call from Morgan Stanley's European equities unit may have also contributed to nervousmness in U.S. markets. The firm issued what it calls a "Full House" sell signal on European stocks based on fundamentals, valuation, and risk indicators.

In the energy markets, July crude oil futures on the NYMEX were up 35 cents to $65.96 a barrel following a weekly Dept. of Energy report that showed crude oil stocks rose by a fewer-than-expected 100,000 barrels.

Among stocks in the news on Wednesday, TD Ameritrade (AMTD) shares gained after it said that two hedge funds, which have accumulated an 8.4% stake and are seeking to acquire more, would like Ameritrade to consider merging with E*Trade Financial Corp. (ETFC) or Charles Schwab Corp. (SCHW). Ameritrade CEO Joe Moglia told CNBC: "We have been talking to people in the industry all along and we will continue to do that." E*Trade shares also gained while Schwab declined.

Prudential Financial (PRU) will shut down its stock research, sales and trading business, effective immediately. About 400 employees are affected by the move. The shares moved lower Wednesday.

Panera Bread (PNRA) shares slumped after the bakery-restaurant chain cut its same-store growth target from 3.4 to 4.5% in the second quarter to 1.5% to 2.5%, and revised its earnings guidance, saying its profit margins are experiencing pressure.

Russ Berrie & Co. (RUS) shares gained after the company said it received, but rejected, an unsolicited offer to buy the company for $18 a share. Its stock closed at $17.71 on Tuesday.

Macrovision Corp. (MVSN) shares rose after the digital content protection outfit announced it will reorganize and cut its worldwide headcount by 7%, taking a $4.5 million restructuring charge in the second quarter. The company forecasts higher earnings per share in 2007 of $1.33 to $1.43, up from $1.25 to $1.35.

European stock markets tanked after the European Central Bank raised its key rate by 25 basis points and Morgan Stanley put out its sell signal on European equities. In London, the FTSE 100 index was down 1.7% to 6,523. Germany's DAX index was off 2.4% to 7,730.05. In Paris, the CAC 40 index moved 1.7% lower to 5.977.87.

Asian markets also moved lower. In Japan, the Nikkei index edged down 0.07% to 18,040.93. In Hong Kong, the Hang Seng Index was off 0.11% to 20,818.61. But China's Shanghai Composite was up 0.24% to 3,776.32.

Treasury Market

Bonds rose modestly Wednesday as stocks skidded. The 10-year Treasury note was up 06/32 in price to 96-13/32 for a yield of 4.970%. The expected test of 5% has sparked some nervousness, notes Standard & Poor's MarketScope.

The 2-year note was up 03/32 to 99-28/32 for a yield of 4.963%, while the 30-year bond was up 04/32 to 94-31/32 for a yield of 5.085%.

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