Fed’s move called into question

NEW YORK —  Yields on long-term Treasury bonds jumped, the U.S. dollar sank and the price of gold surged Thursday, intensifying questions about whether the Federal Reserve’s move this week to stimulate the economy could backfire.

Though the central bank’s cut in short-term interest rates on Tuesday stoked the stock market, it has spooked some other markets -- mainly by raising fears of higher inflation that could undermine the economy.

Those concerns were in focus Thursday in the Treasury bond market, where long-term yields rose for a third day. The annualized yield on the 10-year Treasury note, a benchmark for mortgages, surged to 4.70% from 4.54% on Wednesday and 4.47% on Tuesday.

A major fear is that higher long-term borrowing costs, particularly in the mortgage market, could damp the positive effects the rate cut was expected to have.

“The markets certainly are testing Mr. Bernanke,” said Tom Di Galoma, head of Treasuries trading at brokerage Jefferies & Co. in New York, referring to Fed Chairman Ben S. Bernanke.

After two days of higher prices, the stock market on Thursday gave back some of its Fed-inspired gains. The Dow Jones industrial average eased 48.86 points, or 0.4%, to 13,766.70.

As in the Treasury bond market, the action in currencies and commodities suggested a backlash against the Fed’s rate cut.

The dollar resumed its decline against other major currencies, with the euro reaching a record high of $1.408, up from $1.396 on Wednesday. The greenback also fell to a 31-year low against the Canadian dollar.

Lower short-term interest rates could make dollar-denominated debt less attractive to foreign investors, reducing overseas demand for dollars. And a weaker dollar threatens to boost the price of imported goods, adding to inflation risks.

In commodity trading, gold -- a key barometer of inflation expectations -- soared $9.40 to $732.40 an ounce in New York, a fresh 27-year high.

Inflation fears also were fanned by the continuing rise in oil prices. Crude futures in New York advanced $1.39 to a record $83.32 a barrel.

Many analysts said it was too early to say the drop in the Fed’s key rate, from 5.25% to 4.75%, would do more harm than good.

“I don’t think [the Fed’s move] has in any way backfired,” said Brian Bethune, an economist at Global Insight Inc. in Waltham, Mass. “This has worked exactly the way the Fed wanted it to with . . . a little bit less anxiety about the future of the economy and some movement back into the stock market and other types of risky assets.”

Indeed, the jump in long-term Treasury bond yields in recent days has in part stemmed from some investors’ decisions to sell those securities in favor of riskier corporate debt, bond traders said.

The yield on an index of 100 junk bonds slipped to 8% on Thursday from 8.02% on Wednesday, according to KDP Investment Advisors. The rate now is the lowest since July 18.

Some analysts have pointed to rising Treasury bond yields as a sign that investors were demanding higher returns to compensate for the risk of higher inflation, which is the principal threat to fixed bond rates. If cheaper credit fuels a sharp turnaround in the economy, inflation pressures could increase.

The yield on the 30-year Treasury bond, the most sensitive to inflation issues, ended at 4.97% on Thursday, up from 4.83% the day before.

But David Ader, head of government bond strategy at RBS Greenwich Capital Markets, said he doubted that inflation concerns were more than “a good excuse” for an unwinding of some investors’ rush into Treasuries during the height of the global credit crunch in August.

Whatever is driving long-term Treasury yields up, it’s bad news for the housing market.

“The cost of getting a mortgage has gone up, not down, since rates were cut,” said Jim Keegan, a bond fund manager at American Century Investments in Kansas City, Mo. “So far the market’s voting that [the Fed cut was] not the right thing to do.”

The average rate nationwide for 30-year mortgages edged up to 6.34% this week from 6.31% last week, mortgage finance giant Freddie Mac said Thursday. The 30-year loan rate has mostly been falling since mid-July.

After skyrocketing the day of the Fed rate cut, stocks of most home builders slumped Thursday. Standard Pacific fell 74 cents, or 8.1%, to $8.41. Ryland Group slid $1.96, or 7.5%, to $24.29.

In the broader stock market, the Standard & Poor’s 500 index lost 10.28 points, or 0.7%, to 1,518.75. The Nasdaq composite eased 12.19 points, or 0.5%, to 2,654.29. Losers topped winners by more than 2 to 1 on the New York Stock Exchange.

The stock market is grappling with the mixed effects of the dollar’s ongoing slide, analysts say.

A weaker dollar is good news for U.S. exporters because it makes their products less expensive for foreign buyers.

But if the dollar falls too quickly it could cause new turmoil in global markets. Each drop in the dollar devalues the substantial dollar-denominated investments of foreigners, raising the risk that they will seek to sell some of their holdings.

Many experts believe the dollar is likely to continue to depreciate. “I haven’t seen anything that would reverse the course,” said Dixon Fung, chief of MG Financial Group, a foreign-exchange trading firm in New York.

As it has historically, gold is climbing as the dollar weakens. Gold is considered a haven in uncertain financial times, and the struggling dollar underscores worries about the U.S. economy, some analysts say.

“Gold has been the best long-term barometer of people’s perception of a country or an economy,” said Peter Grandich, who writes the Grandich Letter from Wall, N.J. “And in this case it’s obvious that foreigners don’t have much confidence in the U.S.”

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walter.hamilton@latimes.com