Stocks Rise, Bond Yields Ease Despite Rate Hike

Wall Street seems to have lost its fear of the Fed.

Major stock indexes rose to near three-month highs and long-term bond yields slipped to five-month lows Tuesday, even as the Federal Reserve raised its key short-term interest rate for the third time since June.

Tighter credit often is bad news for financial markets. Bond yields jumped and stocks struggled in the first half of the year as investors began to anticipate the Fed’s first rate increase, which came June 30.

But Wall Street’s concerns about the central bank have been dissipating since early August. The reason: Policymakers, many analysts believe, are close to a near-term “rest stop” in their campaign to lift short-term rates.

“The Fed is very close to moving to the sidelines and adopting a wait-and-see approach,” said David Rosenberg, an economist at Merrill Lynch & Co.

That view has helped to steadily pull stocks up since major market indexes hit 2004 lows Aug. 12. A pause by the Fed could give investors more confidence that the economy would continue to expand in 2005, boosting corporate earnings.

Stocks’ slow-motion rally continued Tuesday, as the Standard & Poor’s 500 index gained 7.10 points, or 0.6%, to 1,129.30, its highest closing level since June 30.

The Nasdaq composite index rallied 13.11 points, or 0.7%, to 1,921.18, its highest since July 13.

The Dow Jones industrial average has been the only laggard among the best-known indexes in recent weeks, but Tuesday it added a respectable 40.04 points, or 0.4%, to 10,244.93.

In the bond market, the slide in long-term yields since early August also is a sign that many investors are expecting the Fed to pause soon, analysts say. If a bond investor figures the Fed’s key short-term rate will be stuck at 2% for a while, then locking in a higher longer-term yield becomes more attractive -- or at least less risky.

The yield on the 10-year Treasury note eased to 4.04% on Tuesday, down from 4.06% on Monday and the lowest since April 1. The yield was 4.42% in the first week of August.

A decline in inflation in recent months, at least as measured by government price indexes, also has cheered bond investors, said Amy Falls, a fixed-income strategist at Morgan Stanley in New York. Inflation is the biggest threat to long-term bonds because it erodes their fixed returns over time.

“I think what has really exited the bond market is a fear of inflation,” Falls said.

The damping of inflation concerns has come even though crude oil prices have rebounded over the last week. Near-term crude futures in New York rose 75 cents to $47.10 a barrel Tuesday, the highest since Aug. 20.

Other factors also explain the drop in longer-term bond yields, analysts said. For example, concerns about the situation in Iraq have encouraged some investors to buy Treasuries as a haven.

The stock market’s rally has in part fed off the bond rally. Any decline in bond yields makes stocks appear less expensive relative to interest rates.

That’s one reason why higher-risk technology stocks have led the market’s rebound since Aug. 12. Nasdaq has risen 9.6% since then; the S&P; 500 is up 6.2% in the same period.

But some analysts say investors may be wrong to bet that the Fed will pause once it reaches the 2% threshold with its key short-term rate.

“I think 2% will look pretty low when we get to year-end,” said David Malpass, an economist at Bear Stearns & Co. in New York. He believes the economy is stronger than many investors have assumed.

Morgan Stanley’s Falls said the 10-year T-note yield could rise significantly next year if the economy’s pace picks up.

“I still feel the 10-year yield ought to be closer to 5% than 4%,” she said. “But it may take longer to get there.”

Among Tuesday’s market highlights:

* Rising stocks outnumbered losers by more than 2 to 1 on the New York Stock Exchange and by slightly less than that margin on Nasdaq.

* Brokerage stocks rallied after Goldman Sachs and Lehman Bros. both reported higher quarterly earnings. Goldman surged $3.22 to $94.90, and Lehman jumped $3.73 to $79.75.

* Home builders soared after Los Angeles-based KB Home reported higher quarterly profit. KB Home leaped $7.11 to a record $83.36. Ryland Group rallied $3.31 to $93.03.

Profit reports from KB Home, Goldman and Lehman helped to take the sting out of recent earnings warnings from a raft of other companies.

* Energy stocks rose with crude oil prices. Exxon Mobil gained $1.28 to $49.49, Marathon Oil was up $1.24 to $40.13 and Sunoco surged $3.04 to $70.44.