Policymakers appear equally worried about inflation and an economic slowdown. Investors were hoping beleaguered insurer AIG could find funding
The Federal Reserve didn't give Wall Street what it wanted on Tuesday. But stocks rallied anyway as the market hoped that someone -- either the government or a private entity -- will extend beleaguered insurance giant American International Group (AIG; -21.2%) a bridge loan of billions to prevent the company from going bankrupt.
The Dow Jones industrial average gained 153.32 points, or 1.4%, to finish at 11,070.83. The broader S&P 500 index added 11.27 points, or 0.94%, to end at 1,203.97. The tech-heavy Nasdaq composite index rose 28.38 points, or 1.3%, to close at 2,208.29, Trading was active and volatile, with indexes slumping in the immediate aftermath of the Fed decision and then heading sharply higher in the session's final hour.
Tuesday's market action followed a vicious sell-off on Monday, in which the Dow tumbled 504.48 points, or 4.42%, to end below the psychologically significant 11,000 level. The "500" sank 4.63% Monday, breaking below its July lows. The Nasdaq slumped 3.6% Monday.
Despite the expectation of some market players that the Fed would lower interest rates in response to the current crisis on Wall Street, the central bank stood pat at its policy meeting Tuesday. Policymakers seem equally worried about inflation and an economic slowdown.
Bonds fell in price Tuesday after the Fed decision. The dollar index was up. Gold was lower, as were crude oil futures. Global central banks were injecting funds into the banking system to keep credit markets functioning, according to S&P MarketScope. The Fed injected another $50 billion of funds into U.S. markets Tuesday.
In its post-meeting statement, the policy-setting Federal Open Market Committee said that keep it was keeping its target for the federal funds rate at 2%.
"Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending," said the FOMC.
The Fed said tight credit conditions, the ongoing housing contraction, and some slowing in export growth were likely to weigh on economic growth over the next few quarters.
But the central bank added that "Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth."
The Fed said that inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Fed expects inflation to moderate later this year and next year, but the outlook remains "highly uncertain".
The Fed concluded by saying that the downside risks to growth and the upside risks to inflation "are both of significant concern" to policymakers. "The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability."
"The Fed made clear that it is not yet willing to take chances with respect to inflation," wrote Tony Crescenzi, chief bond market strategist for Miller Tabak. "Nevertheless, the Fed did clearly lean toward the possibility of interest rate cuts with its opening remarks about financial markets and labor market conditions."
"The [Fed's] statement was more balanced than I expected, with no indication of future rate cuts," wrote S&P chief economist David Wyss in a note Tuesday. "There may still be some quantitative easing through an expanded credit line, but there is no indication of that in this statement."
On Tuesday, Wall Street was still feeling the aftershocks of a momentous weekend that featured Lehman Brothers' (LEH; -11.4%) bankruptcy filing and Bank of America's (BAC; +11.3%) agreement to buy Merrill Lynch (MER; +30%).
Investors remained nervous as another potential calamity loomed: AIG, battling credit downgrades and market worries about its exposure to credit default swaps, is seeking billions of dollars to stay afloat.
The market was speculating about what role the Federal Reserve might play in efforts to resolve AIG's liquidity problems. According to a CNBC report late in Tuesday's session, the Fed has reviewed AIG's books and has a good idea of what the firm needs. There is some hope the Fed will have something together by end of the day (not the business day). If not, it is likely AIG will file for bankruptcy.
Late Monday, S&P Ratings Services lowered its long-term counterparty rating on AIG to A- from AA- and its short-term counterparty credit rating on AIG to A-2 from A-1+. A.M. Best Co. downgraded the firm's financial strength rating to A (Excellent) from A+ (Superior) and issuer credit ratings of the domestic life and retirement services subsidiaries of AIG to a from aa.
Credit Suisse slashed its target price on AIG to reflect what it thinks to be the heightened probability of a potential bankruptcy filing.
Former AIG CEO Hank Greenberg indicated in a CNBC interview that if the insurer didn't get a bridge loan from the private or public sectors and the ratings agencies give the company "breathing space," it would be a disaster if AIG went under, creating a systemic problem that would take years to unravel given massive counterparty risks.
Washington Mutual (WM; +16%) was also in the ratings crosshairs Tuesday as its corporate credit rating was cut to junk late Monday. S&P Ratings Services lowered its counterparty credit rating on WaMu to BB-/B from BBB-/A-3. S&P also lowered its rating on Washington Mutual Bank to BBB-/A-3 from BBB/A-2. S&P's ratings outlook is negative. S&P said the current ratings and negative outlook assume an improvement in earnings for thje second half of 2008, but a loss for the full year.
On the Lehman front, the Financial Times reports that the bankrupt firm reached a deal to sell certain parts of its business to Barclays (BCS; +7.9%), which had been in talks over the weekend to buy the entire investment bank before it filed for bankruptcy protection on Monday. The two parties reached a deal in the early New York morning, though the exact Lehman businesses involved, and the price at which they will be sold, remained unclear. A deal could be accompanied by a small capital raising by the UK lender.
Wells Fargo (WFC; +12.7%) says that, as a result of the Chapter 11 filing by Lehman, it will record other-than-temporary impairment and take a non-cash charge to earnings in the third quarter for its investments in senior unsecured notes and perpetual preferred securities issued by Lehman. Wells Fargo says its investments in the notes and preferred securities are included in securities available for sale at a cost of about $90 million and $109 million, respectively.
The demise of Lehman was having an impact on companies outside the financial sector. Evergreen Solar (ESLR; -3.7%) said that in connection with its Senior Notes offering, it entered into a capped call transaction with Lehman Brothers OTC Derivatives to reduce ultimate dilution that would otherwise occur. The company said it working with several investment banks to determine its best course of action to maintain the original intent of the capped call transaction. Evergreen also entered into common stock lending agreement with Lehman Brothers International (Europe) pursuant to which Evergreen loaned 30.9 million ESLR shares to Lehman Brothers International.
Also, Lehman was to be be removed from the S&P 500 index after the close of trading on Sept 16. Lehman's place in the S&P 500 will be taken by Harris Corp. (HRS; +3.5%) , and Harris will be replaced by Greif (GEF; +6.6%) in the S&P MidCap 400, all after the close of trading on Sept. 19.
Another big Wall Street firm posted results Tuesday morning. Goldman Sachs (GS; -4%) reported third quarter earnings per share of $1.81, vs. $6.13 one year earlier, on a 43% total revenue decline. The company's effective income tax rate for first none months of fiscal 2008 was 25.1%, down from 34.1% in fiscal 2007. Net revenues in Investment Banking fell 40% year-over-year and 23% from the second quarter. Net revenues in Fixed Income, Currency and Commodities were 67% lower than a very strong year-earlier quarter, primarily reflecting particularly weak results in credit products and mortgages.
Meanwhile, Morgan Stanley (MS; -10.8%) said that in order to provide the market with information on its financial performance in the most timely manner possible, it would hold its third quarter conference call Tuesday at 5:00 p.m. ET.
The U.S. CPI dipped 0.1% in August, while the core rate edged up 0.2%, about in line with expectations, and compared to gains of 0.8% and 0.3%, respectively, in July. On a year-over-year basis, the headline pace slowed to 5.4% compared to 5.6% in July. The year-over-year core rate was steady at 2.5%. As expected, energy was behind the softer trend, tumbling 3.1% on the month, after soaring a cumulative 15% over the prior three months. Energy prices are still up 27.2% year-over-year, compared to a 29.3% clip previously.
"The data reflect some of the softening in commodity prices, but won't have much market impact amid the ongoing credit turmoil," wrote Action Economics analysts in a website posting Tuesday.
"The expected softening in commodity prices is good news, and gives the Fed more room to move. However, it won't likely have much market impact," wrote S&P senior economist Beth Ann Bovino in a note Tuesday.
The National Association of Home Builders/Wells Fargo Housing Market Index rose two points to 18 in September from a record low 16 for the previous two months. Though this month's increase to the index is good news, any reading below 50 means there are still more builders who see conditions as poor than those who see conditions as good. The measure of current sales conditions rose one point to 17, the gauge of sales expectations for the next six months rose six points to 30, and the traffic of prospective buyers rose one point to 14. All regions posted some degree of improvement, with the Midwest, South and West each up two
points and the Northeast posting a six-point gain to 22.
Treasury Secretary Henry Paulson canceled his speech on the economy and housing market at an event on electronic payments sponsored by the Brookings Institution in Washington, D.C. He "is focused on staying on top of market developments today" and Undersecretary David McCormick will deliver the speech. Earlier Senator Richard Shelby on CNBC also indicated that hearings on the bailout of housing agencies Fannie and Freddie would likely be postponed as well, and that he planned to speak with Paulson within the hour on developments in the financial markets.
Energy futures were lower Tuesday afternoon as the Wall Street financial crisis threatened to add to growing global recession that would likely reduce demand for oil and other commodities. October WTI crude oil futures were off $4.07 to $91.64 per barrel, the lowest level since February.
December gold futures were down $5.40 at $781.60 per ounce.
Among Tuesday's other stocks in the news, Hewlett-Packard (HPQ; +6.8%) says it plans to implement a restructuring program for the recently-acquired EDS business group. As part of the plan, H-P will reduce workforce by about 24,600 employees, or about 7.5% of the combined company's workforce, with nearly half of the reductions occurring in U.S.
Dell Inc. (DELL; -11.2%) said it is seeing further softening in global end-user demand in the current quarter.
International Rectifier (IRF; +0.9%) rejected Vishay Intertechnology's (VSH; -1.7%) revised $23 per share buyout proposal. IRF says the offer significantly undervalues the future prospects of the company and is not in the best interest of its shareholders.
CBRL Group (CBRL; +12%) reported fourth quarter EPS from continuing operations of 91 cents, vs. $1.15 one year earlier, on 0.8% lower same-store sales and 4.8% lower total sales. The company sees 2%-3% fiscal 2009 same-store sales growth, 4.5%-5.5% total sales growth, and EPS from continuing operations of $2.80-$3.00.
European indexes pulled back from earlier losses Tuesday. In London, the FTSE 100 index was lower by 1.63% to 5,119.60. In Paris, the CAC 40 index shed 0.71% to 4,139.18. Germany's DAX index fell 1.11% to 5,997.06.
Asian markets, which were closed for holiday Monday, made up for lost time with sharp losses Tuesday. Japan's Nikkei 225 index fell 4.95% to 11,609.72. In Hong Kong, the Hang Seng index plunged 5.44% to 18,300.61.
Bonds, which soared Monday on Lehman's weekend bankruptcy filing, were lower after the FOMC decided not to change rates. The 10-year note was off 25/32 to 104-07/32 for a yield of 3.500% and the 30-year bond fell 30/32 to 106-31/32 for a yield of 4.095%.