The Federal Reserve warned of weak economic growth and the threat of inflation Tuesday, and the stock market loved it.
There was little surprise in the Fed's decision to hold the federal funds rate at 2%, but something about the afternoon news still cheered investors. Stocks rallied in the morning, supported by better-than-expected economic data and falling oil prices, but rose even higher after the Fed issued its statement.
Traders may have been relieved by the growing notion that the Fed won't be raising interest rates anytime soon. "The Federal Reserve said little new," said Marc Chandler of Brown Brothers Harriman. The statement, however, "gives little reason to expect a [September] rate hike, which we previously had thought was possible."
On Tuesday, the Dow Jones industrial average rose 331.62 points, or 2.94%, to 11,615.77. The broader S&P 500 index added 35.87 points, or 2.87%, to 1,284.88. The tech-heavy Nasdaq composite index rose 64.27 points, or 2.81%, to 2,349.83.
On the New York Stock Exchange, 24 stocks moved higher for every 8 in negative territory. On the Nasdaq, the ratio was 19 to 9 positive.
Oil prices fell below $120 per barrel to its lowest price since early May. On the NYMEX, crude oil for September delivery fell $2.24 to $119.17 per barrel. The U.S. average for a gallon of gasoline fell 1 cent to $3.871.
Also helping stocks rally Tuesday morning was better-than-expected reading from the service sector. The U.S. ISM services composite index improved to 49.5 in July after falling over 3 points to 48.2 in June. The general activity index was little changed at 49.6 from 49.9. The employment component rose to 47.1 after hitting a record low at 43.8 in June. New orders index slipped to 47.9 from 48.6. New export orders slid to 47.9 from 52.0, back below 50 for the first time since February. Prices paid fell to 80.8 from the record 84.5 in June.
Fed-watchers carefully read the Fed's statement for clues to future policy moves. Some think growing inflation pressures will eventually push the Fed toward higher interest rates, with the Fed future market expecting a rate hike in December. But the statement barely changed from last month's meeting.
"While the Committee is undoubtedly concerned about inflation, the statement points to an expected moderation in inflation and implicitly notes the recent fall in energy and some commodity prices," wrote John Ryding of RDQ Economics. At the same time, the Fed apparently expects several quarters of weak economic activity, translating into higher unemployment into 2009, added Ryding, who believes the Fed won't change interest rates until next year.
In its statement, the central bank noted that economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. But “labor markets have softened further and financial markets remain under considerable stress.” The Fed added that tight credit conditions, the ongoing housing contraction, and elevated energy prices “are likely to weigh on economic growth over the next few quarters.”
“Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth,” the Fed said.
The Fed’s release stated that inflation has been high, “spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated.” The Fed expects inflation to moderate later this year and next year, but the inflation outlook remains “highly uncertain."
The Fed concluded: “Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.”
The Fed meeting was again marked by dissent, with Dallas Fed president Richard Fisher breaking from the FOMC ranks to vote for a rate hike.
August gold futures were lower at $882.50 per ounce. The U.S. dollar strengthened against the euro, which fell 0.79% to $1.5454.
Among Tuesday's stocks in the news, Procter & Gamble (PG) reported fourth quarter earnings per share of 92 cents, vs. 67 cents one year earlier, on a 10% revenue rise. The company sees fiscal 2009 EPS of $4.18-$4.25 (GAAP basis), which includes an estimated 50-cent gain from the sale of its Folgers coffee business and a 12-cent investment in incremental restructuring.
Bankrate (RATE) posted second quarter adjusted operating EPS of 39 cents, vs. 35 cents one year earlier, on a 73% revenue rise. As previously announced on July 7, the company lowered its 2008 annual guidance as a result of softness in display advertising. The company expects annual revenue to be between $164-$169 million and adjusted EBITDA of $54-$58 million. Jefferies cut its price target on the shares to $35 from $54. The firm also cut its estimates on Bankrate and reiterated its hold recommendation.
Molson Coors Brewing (TAP) reported second-quarter non-GAAP EPS (underlying after-tax income) of 93 cents, vs. 97 cents one year earlier, as higher special charges, increased energy and commodity inflation in all markets, and a higher effective tax rate for the second quarter offset a 4.8% sales rise.
Marvel Entertainment (MVL) posted second-quarter EPS of 59 cents, vs. 34 cents one year earlier, on a 55% sales rise. The company sees $1.55-$1.75 2008 EPS on revenue of $450-$480 million. Marvel’s guidance now includes results from its Film Production unit.
Archer-Daniels-Midland (ADM) posted lower-than-expected fourth-quarter EPS of 58 cents, vs. $1.47 one year earlier, on a 78% revenue rise. Wall Street was looking for a profit of 67 cents. The company notes results in the prior-year period include after-tax gains on asset sales of 95 cents per share.
Tenet Healthcare (THC) posted a second-quarter loss of 3 cents per share vs. a loss of6 cents one year earlier on a 6.3% revenue rise.
Allied Capital (ALD) posted a second-quarter loss of 59 cents per share vs. 57 cents EPS one year earlier as a net change in unrealized appreciation or depreciation offset a 14% rise in total interest and related portfolio income.
CNBC reports Lehman Brothers Holdings (LEH) is considering selling its entire investment management business, including private equity and hedge fund stakes, rather than just its Neuberger Berman business, as the bank looks to raise capital.
UBS reportedly initiates coverage on Apple Inc. (AAPL) with a buy rating.
UBS also reportedly upgraded American International Group (AIG) to buy from neutral.
Major European indexes were trading higher Tuesday. In London, the FTSE 100 index climbed 2.52% to 5,454.50. In Paris, the CAC 40 index rose 2.47% to 4,386.35. Germany’s DAX index gained 2.66% to 6,518.70.
Major Asian equity indexes lost ground Tuesday. Japan’s Nikkei 225 index fell 0.14% to 12,914.66. In Hong Kong, the Hang Seng index tumbled 2.51% to 21,949.75.
Treasuries fell Tuesday. The 10-year note lost 15/32 to 98-26/32 for a yield of 4.02%, while the 30-year bond dropped 28/32 to 95-22/32 for a yield of 4.64%. The U.S. government will sell $17 billion of 10-year notes on Wednesday and $10 billion of 30-year bonds on Thursday.