Closing Market Report

Star-Bulletin news services

Investors fear
rising interest rates
will derail already
shaky recovery

NEW YORK >> Wall Street had to face another hard reality this past week: Interest rates are rising, and threatening to undermine an already uncertain economic recovery.

Rising rates are "front of mind for everyone," said Mark Jordahl, chief investment officer at US Bancorp Asset Management.

The turnaround in rates actually isn't that surprising, but investors nonetheless were unnerved by the idea that higher borrowing costs will deter consumers from spending and companies from expanding.

Since the middle of June, the yield on the 10-year Treasury note has risen to about 4.3 percent from just over 3.0 percent, due largely to signals that the economy is rebounding and the Federal Reserve is being less aggressive about keeping rates lower as an economic stimulus.

The stock market has responded with declining prices.

"The reason the stock market is essentially stalled out is because not only did interest rates rise, but they have risen more sharply than they have at any time since May 1987, and in percentage terms they have risen more sharply since any time since 1962," said Hugh Johnson, chief investment officer at First Albany Corp.

Market analysts say the higher rates aren't warranted in an economy that remains far from robust, even fragile.

"We think the spike in interest rates is overdone. But if these yields go higher, the recovery we have been hoping for might be a little less robust," said Greg Valliere, chief strategist of Schwab's Washington Research Group, in a report out yesterday.

Among the data that fail to support the need for higher rates, Valliere cited an unemployment rate of 6.2 percent. He also said there's no evidence to say that inflation is back.

Another reason for higher rates is that the Federal Reserve has indicated it will be less aggressive, after having slashed rates 13 times since early 2001 to stimulate the economy. The Fed meets on Tuesday, but is widely expected to leave rates unchanged.

In his report, Valliere acknowledged that there are signs of strength in the economy that could be behind the rising rates. For example, corporate inventories fell considerably in the second quarter, according to the Commerce Department's report on the gross domestic product. That suggests that demand for goods is increasing.

Aside from a big sell-off on Tuesday, when the Dow Jones industrials dropped 149.72 points, the market handled its fears about interest rates rather well this past week.

The Dow managed to end the week up 0.4 percent. For the week, the Nasdaq composite index forfeited 4.2 percent, while the Standard & Poor's 500 index declined 0.3 percent.

The gauges also remain well above their March 11 lows for the year. The Dow is up 22.2 percent from those lows. The Nasdaq is up 29.3 percent, while the S&P is up 22.1 percent.

"It is comforting the equity market has digested the rise in rates so well," Jordahl said.

Still, investors are somewhat torn about how to read the higher rates. On the upside, rising interest rates could signal that the economy is improving. But the question remains if the rising rates are premature, given the still shaky recovery.

The Dow ended the week up 37.12, closing yesterday at 9,191.09.

The Nasdaq had a weekly loss of 71.59, finishing at 1,644.03 yesterday. The S&P had a weekly decline of 2.56, closing at 977.59.

For the week, the Russell 2000 index fell 14.14, or 3 percent, closing at 453.94.

The Wilshire 5000 Total Market Index, which tracks more than 5,700 U.S.-based companies, ended the week at 9,392.73, up 30.35 from the previous week. A year ago, the index was at 8,571.87.

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