Stocks Rally on Fed Rate Increase

The Federal Reserve gave the economy a vote of confidence Tuesday, and that was what Wall Street wanted to hear.

Stocks rallied sharply after Fed policymakers raised their benchmark short-term interest rate from 1.25% to 1.5% and seemed to declare themselves satisfied that the nation remains on a healthy growth track.

Major market indexes, hammered in recent weeks on concerns about the economy, soaring oil prices and terrorism warnings, had their biggest one-day gains in at least two months.

In other trading, Treasury bond yields rose and the dollar strengthened modestly. Oil prices eased.

On Wall Street, the Dow Jones industrial average jumped 130.01 points, or 1.3%, to 9,944.67.

The Nasdaq composite index surged 34.06 points, or 1.9%, to 1,808.70, and the Standard & Poor’s 500 index was up 13.82 points, or 1.3%, to 1,079.04.

The market rallied early in the day, pulled back immediately after the Fed’s announcement at about 11:15 a.m. PDT, then shot higher in the final 90 minutes of trading. Most key indexes closed at their highs for the session.

The central bank, in its post-meeting statement, said the economy seemed ready “to resume a stronger pace of expansion” after recent softness.

“They essentially said, ‘Calm down, don’t worry,’ ” said Charles Crane, strategist at Scotsman Capital Management in New York.

That was a relief to some investors who have been concerned that the economy might slump, dragging down corporate earnings.

Although there was little question on Wall Street that the Fed would raise its benchmark rate for the second time since June 30, many analysts thought the Fed might hint in its statement that it could halt its credit-tightening push in the fall, if business activity weakened further.

But “they didn’t back down,” said Joel Naroff, head of Naroff Economic Advisors in Holland, Pa. That showed confidence in the idea that “the economic expansion is set,” he said.

The stock market was poised for some kind of bounce after the beating it has taken in recent weeks, analysts said.

Key indexes tumbled in July and in recent days have hit their lowest levels since last year, after the government on Friday said the economy created a net 32,000 jobs in July -- far below expectations.

Tuesday’s rebound didn’t recoup much of what stocks have lost; the Nasdaq index, for example, fell nearly 6% last week.

But market bulls have been hoping for some kind of snap-back to encourage bargain hunters.

“I think there’s reason to be bullish,” said Robert Millen, co-portfolio manager with the Jensen Portfolio in Portland, Ore. “What gives me a lot of comfort in the long term is that there are a lot of good things going on in the economy. Companies that have good pricing power and competitive advantages are going to do well.”

Rising stocks outnumbered losers by more than 2 to 1 on the New York Stock Exchange and on Nasdaq. Trading volume, however, remained subdued, suggesting a lack of conviction on the part of buyers.

In the bond market shorter-term Treasury yields were up sharply, reflecting renewed expectations that the Fed would continue to raise its benchmark rate through the fall.

A Reuters poll of 19 major bond dealers found that 14 believe the Fed will boost its rate another quarter point at the policymakers’ Sept. 21 meeting.

The two-year T-note yield jumped to 2.53% from 2.44% on Monday.

But longer-term yields were more restrained. The 10-year T-note yield edged up to 4.29% from 4.26%.

By continuing to tighten credit, one of the Fed’s principal goals would be to restrain inflation -- a paramount issue with investors in long-term fixed-rate securities. That may have kept a lid on longer-term yields on Tuesday, analysts said.

In other markets, the dollar gained ground, but the advance was muted.

Near-term crude oil futures in New York dropped 32 cents to $44.52 a barrel from Monday’s record high.

Oil fell on a report that Iraq restored the flow of petroleum to southern export terminals, after halting flows Monday amid fears of attacks by insurgents.

Among the day’s market highlights:

* Heavy industry stocks helped pace the rally, on hopes that the economy remains strong. Eaton jumped $1.87 to $63.12, copper miner Phelps Dodge soared $3.64 to $77.76 and Cummins was up $2.67 to $68.20.

* Transportation stocks were strong. The Dow transports index rose 2.5%. Railroad Burlington Northern gained 85 cents to $35.05, JetBlue Airways surged $1.18 to $23.13 and Yellow Roadway leaped $1.60 to $42.39.

* Banks also rallied. They also would benefit from a stretched-out economic expansion, even if interest rates rise gradually, analysts said. J.P. Morgan Chase rose 92 cents to $36.99, City National added $1.22 to $63.40 and Bank of America was up $1.07 to $85.

* In the technology sector, IBM rose $1.44 to $84.99, Microsoft gained 54 cents to $27.72 and InfoSpace jumped $1.78 to $35.28.

Nvidia, the world’s biggest maker of computer-graphics chips, climbed 78 cents to $10.63. The company said it might buy back up to $300 million in stock. The shares dived $5.13 on Friday after the company reported lower-than-expected earnings.

* Biotechnology stocks attracted buyers. Genentech rose $1.27 to $45.45, Biogen Idec gained $1.58 to $56.81 and Gilead Sciences rallied $2.40 to $64.07.

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Outlook for key rates

The Federal Reserve raised its benchmark short-term rate a quarter of a percentage point Tuesday, the second increase since June 30.

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Item: Prime lending rate

Current rate: 4.50%

Outlook: Many major banks raised the prime a quarter-point on Tuesday, from 4.25%, matching the Fed’s increase. Most banks are expected to follow. The prime, a benchmark for many consumer loans, usually changes in tandem with Fed shifts.

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Item: Money market mutual fund average yield (seven day)

Current rate: 0.77%

Outlook: Money fund yields usually track Fed rate changes, with a lag of six to eight weeks. So the average fund yield could be near 1% by late September.

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Item: Six-month CD yield (U.S. average)

Current rate: 1.25%

Outlook: CD yields have been rising slowly since spring, and the Fed’s move is expected to keep upward pressure on yields.

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Item: 10-year Treasury note yield

Current rate: 4.29%

Outlook: Long-term bond yields have fallen since mid-June, when the 10-year T-note peaked at 4.87%. Concerns about a slowing economy have pulled long-term yields lower even as the Fed has raised short-term rates. Renewed economic strength could lift bond yields again.

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Item: 30-year mortgage rate (Freddie Mac average)

Current rate: 5.99%

Outlook: Mortgage rates generally follow long-term bond yields. The 30-year loan rate has fallen from 6.32% in mid-June.

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Sources: Informa Research Services, ImoneyNet Inc., Bloomberg News

Graphics reporting by Tom Petruno