International markets: New York - Foreign tensions cloud Wall St

Rising tensions in the Middle East and lingering uncertainty about the prospects for South-east Asian economies will cast a pall over the US stock market in the days ahead. On the other hand, some bond investors are contemplating what just a month or so ago seemed unthinkable: a Federal Reserve rate cut in 1998.

"There's a higher probability over the next three to six months that the Fed would ease interest rates rather than tighten," said Harvey Hirschhorn, manager at Stein Roe & Farnham in Chicago.

But until investors have a better understanding about the consequences of the developments overseas, they will be reluctant to commit new money to the stock market. "The psychology of the market is pretty negative," said Ed Haldeman, a partner at Cooke & Bieler in Philadelphia.

For the week, the Dow lost 8.84 points, about a 10th of 1 per cent. The Standard & Poor's 500 added 0.84 of a point. The Nasdaq Composite Index, lost 1.2 per cent.

The turmoil abroad has overshadowed some positive developments at home, money managers said. Economic reports last week showed that inflation remains at bay, which sent bond yields lower and increased the likelihood that the Federal Reserve will stand pat on interest rates into 1998.

The yield on the benchmark 30-year Treasury bond, which sets lending rates around the globe, fell to 6.09 per cent on Friday; three months ago, the yield was 6.55 per cent.

"We're seeing some improving fundamentals in the economy, in terms of interest rates," said Charles White, at Avatar Associates. "Turmoil in foreign currencies keeps the Fed out of the game and allows interest rates to drift lower. That's supportive for equities."

That thinking, combined with signs the economy may be losing steam, has some investors looking for a rate cut in the months ahead. Until recently, robust economic growth and the lowest unemployment rate in a generation had many investors convinced that the Fed would need to boost bank lending rates soon to keep inflation from accelerating. Among those was William Gross, chief investment officer of Pacific Investment Management and one of the most closely watched bond investors, who a month ago was looking for a rate increase - until the recent market turmoil in Asia.

"Now my sense is that ultimately the Fed lowers rates as opposed to raises them," said Mr Gross. He predicts yields on benchmark 30-year bonds may fall below 5.5 per cent next year.

Fed Chairman Alan Greenspan in Congressional testimony on Thursday said troubles in Asia were one of the reasons the Fed left bank lending rates steady earlier this week.

Copyright: IOS & Bloomberg