Stocks, bonds climb as rates rise

May 18, 1994|By Bloomberg Business News The New York Times New Services contributed to this article.

NEW YORK -- U.S. government bonds staged their biggest one-day gain in more than three years yesterday after the Federal Reserve raised interest rates to contain inflation, and the Dow Jones industrial average rose to its highest point in six weeks.

Equally important, analysts said the Fed's move was likely to help stabilize market conditions into the summer, thereby ending a period of chaotic volatility that has persisted since early February.

Stock and bond traders moved within seconds of the Fed's action to bid up prices, and continued to do so until the markets closed.

The Fed raised the rate on overnight bank loans to 4.25 percent, up a half-percentage point, and raised the discount rate for the first time since 1989, to 3.50 percent from 3 percent.

"Everyone was afraid there would only be a quarter-point increase, but we got half a point, which is very bullish for stocks," said Morty Schaja, a managing director at Baron Capital Management.

Computer-guided orders to buy stocks kicked in just after the Fed said it raised rates, pushing the Dow Jones industrial average higher, according to Birinyi Associates.

The Dow industrials rose 49.11, to 3,720.61, its fourth consecutive advance and the highest level since March 28. International Business Machines Corp., McDonald's Corp. and Aluminum Co. of America were the biggest gainers.

Bond yields plunged after the Fed raised rates, signaling its resolve to keep inflation -- the bond market's enemy -- under control. The yield on the benchmark 30-year bond fell to 7.27 percent, the lowest level in more than two weeks and down from 7.45 percent at Monday's close. It was the biggest one-day rally since Jan. 17, 1991, the day after the United States launched its air war in the Persian Gulf.

The Standard & Poor's 500 index rose 4.88, to 449.37. Utilities, retailers and auto stocks accounted for most of the advance.

Meanwhile, a rout of technology stocks pushed the Nasdaq combined composite index 0.39 lower, to 711.52. U.S. Healthcare Inc., Lotus Development Corp. and Xilinx Corp. paced the decline.

"Technology stocks are in a corrective phase -- the baby is being thrown out with the bathwater," said Arnold Owen, stock trader at SoundView Financial Group.

About 13 stocks rose for every eight that fell on the New York Stock Exchange. About 311 million shares changed hands by the close of trading on the Big Board.

Some stock investors expect the increase in the federal funds rate to quell, at least temporarily, concerns about rising rates, setting the stage for a rise in stock prices.

Even though the Fed had raised short-term rates three times since February, those actions were deemed insufficient. But now, and for the time being, the markets seem satisfied.

"I think the Fed is kowtowing to the market," said Edward J. Hyman, an economist and president of the ISI Group Inc., a New York investment firm. "But in this case, it was probably not a bad idea."

But Thom Brown, managing director at Rutherford, Brown & Catherwood in Philadelphia, expects any rally in stocks will be short-lived. "I don't think it will last," he said.

Higher rates increase the cost of doing business for companies and consumers, cutting into corporate earnings. Higher rates also lure investors from stocks into lower-risk fixed income investments.

"An increase in rates is never good for stocks," said Anthony Dwyer, chief market strategist at Sherwood Securities.

Said Mr. Brown: "I think the market is exhibiting all of the characteristics of a bear market. But this is a constructive bear market -- there are a lot of things that are getting cheap." Auto stocks and chemical companies have become attractively priced amid the stock market's decline, Mr. Brown said.

U.S. Healthcare Inc. fell $1.50, to $35.50, on concern that the health maintenance organization's membership won't grow fast enough to support analysts' most optimistic earnings expectations.

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