Stocks Break Even After Rate Cut

The Fed slashed by 50 basis points and stocks hardly budged, but bonds sold off as interest rates neared their lows of the easing cycle

Stocks finished nearly unchanged on Tuesday, May 15, while bonds fell sharply after the Federal Open Market Committee (FOMC), the policy-making arm of the Federal Reserve, cut key interest rates by 50 basis points.

The Dow Jones Industrial Average finished off 4.36 points, or 0.04%, to 10,872.97. The Nasdaq Composite index tacked on 3.84 points, or 0.18%, to 2,085.76. Meanwhile, the broader S&P 500 inched higher 0.52 points, or 0.04%, to 1,249.44.

"The market pretty much got what had been expected and the Fed said what was expected," says Richard Berner, chief U.S. economist at Morgan Stanley Dean Witter. "But they left their options open. For now they still see the risks are toward weakness, rather than rising inflation."

Evidence of an economic rebound -- strong numbers in retail sales and consumer sentiment -- over the last few sessions had cast doubt on whether the Fed would cut by the expected 50 basis points.

But the Alan Greenspan & Co. apparently believe that another cut was needed to pump up a sagging economy. Tuesday's rate cut is the fifth so far this year, bringing the key Fed funds down 2.5 percentage points, to a rate of 4% - the lowest in seven years. The discount rate was also lowered by 50 basis points to 3.5%.

The wording of the Federal Reserve's policy statement suggests that the central bank is not yet ready to end the current easing cycle. Future rate cuts are not out of the question. In fact, the Fed's statement is extremely cautious. "This potential restraint [in capital spending], together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, continues to weigh on the economy."

"This is a more favorable statement than I had expected in the sense of generating further rate cuts," says David Wyss, chief economist at Standard & Poor's. "They don't want a recession. So they would rather make a mistake and have too much growth instead of too little."

For now the Fed is not overly concerned with inflation. "With pressures on labor and product markets easing, inflation is expected to remain contained," the Fed says. Brener agrees with the Fed's view. He expects Wednesday's read on the Consumer Price Index, a key gauge of inflation at the consumer level, to show an increase in the headline figure of 0.3% and an increase in the core figure by 0.2%.

Wyss is more worried about inflation. He cautions that the rise in energy prices has not spread, but "given unit labor cost increase, I'm not sure the Fed can ignore it quite as much."

Among Tuesday's stocks in the news, the world's biggest retailer, Wal-Mart Stores Inc. (WMT ), said first-quarter earnings rose 4%, in line with lowered expectations, as a slower consumer spending hurt profit growth.

Treasury Market

U.S. Treasuries were trading off after the Fed announced a 50 basis-point rate cut. "The bond market is concerned that the Fed's reflationary efforts will turn into inflation," Berner says. The outlook for Treasurys worsens as interest rates fall to the low point of the easing cycle and the economy starts to respond to the Fed's cuts,

In economic data Tuesday, the Redbook retail sales report showed a gain of 0.5% for the week ended May 12. This was slower than the 0.8% gain reported for the last period, according to its weekly survey. The report added that sales were on or below plan for most retailers, though the Mother's Day holiday increased sales of cosmetics, accessories, and jewelry.

World Markets

European markets finished higher, after selling off on Monday. London's Financial Times-Stock Exchange 100 index ended up 152.40 points, or 2.68%, to 5,842.90. Germany's DAX Index added 5.70 points, or 0.09%, to 6,070.38. In Paris, the CAC 40 gained 56.41 points, or 1.03%, to 5,544.13.

Asian markets ended mixed. Japan's Nikkei 225 index advanced 181.01 points, or 1.30%, to 14,054.03. In Hong Kong, the Hang Seng index lost 9.08 points, or 0.07%, to 13,250.09.

By Amy Tsao in New York

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