Transcripts

The Rising Interest Rate Sparks Stock Sell Off

SUSIE GHARIB: Interest rate worries dominated Wall Street today. The Dow fell 65 points, but the NASDAQ edged up three points. Stocks sold off as investors grew concerned that inflation pressures will force the Federal Reserve to keep raising rates. Suzanne Pratt takes a look at the correlation between interest rates and stock prices.

SUZANNE PRATT, NIGHTLY BUSINESS REPORT CORRESPONDENT: Conventional Wall Street wisdom says rising interest rates are often bad news for stocks. That`s because higher yields make bonds an attractive alternative and borrowing costs get more expensive for corporate America. But in the most recent tightening cycle, U.S. stocks have behaved surprisingly well. Since the Federal Reserve began raising rates in June 2004, the Dow, S&P 500 and NASDAQ have all posted solid gains. Experts say that`s partly because the Fed began raising rates when the Federal funds rate was at its lowest level in more than half a century.

ART HOGAN, CHIEF MARKET ANALYST, JEFFERIES & CO.: Starting from a very low base, it`s not unusual to see the economy continue to do better, earnings continue to do better for corporate America. And the market has not necessarily sold off as we`ve seen interest rates rise up.

PRATT On top of that, the Fed has recently been more open with financial markets. So the past 15 rate increases were not a surprise. Nevertheless, most stock investors are counting on the Fed to stop raising rates soon. They`re betting the central bank will bring the Fed funds rate to 5 percent at its May meeting and then take a break. But what happens to stocks if the Fed keeps going? Some experts say it won`t be good.

KEVIN BANNON, CHIEF INVESTMENT OFFICER, THE BANK OF NEW YORK: I think if people perceive that the Fed is going to go much higher, they`re going to start marking down their growth forecasts, because it clearly suggests that the Fed is much more concerned about inflation than they are about growth and willing to risk a potential slowdown or even recession. So anything north of five would be a negative for the stock market.

PRATT: Others believe the stock market can handle a Fed funds rate up to 5.25 percent. But they`re worried about what happens if the Fed keeps raising rates through the summer.

HOGAN: If we have anything with a 6 handle on it by year end on the Fed funds rate, I certainly think that will act as a major deterrent in this economy. I think that will act as a major deterrent in corporate earnings. And I certainly think that will act as a major draw for what otherwise would be equity investments into the bond market.

PRATT: It may be worth noting that the yield on the 10-year Treasury rose today to its highest level in nearly two years, close to 5 percent. Experts say many bond investors believe the Fed is nowhere near done raising rates. Suzanne Pratt, NIGHTLY BUSINESS REPORT, New York.