New York market: Stocks could gain if Fed takes it easy

Dow Jones

INVESTORS expect the Federal Reserve to raise interest rates next Wednesday. The questions now are by how much and what will the impact be.

"There is a 75 per cent chance of a 25-basis-point increase, which with no other comment will be a non-event," said Uri Landesman, at Aaron Fleck, a money manager. He said there was a 10 per cent chance of a 50-basis- point rise, which would be a "little more negative" for stocks.

By all accounts, a rate cut has been discounted. If expectations are correct, stocks should gain in coming weeks. Almost as important as the decision on rates are any hints the Fed gives about future changes.

"We are waiting for any commentary as the Fed could still say something that will make people uncomfortable," Mr Landesman said. Some investors believe even a 50-basis-point increase may send shares higher as it erases uncertainty about other increases later in the year.

"In some ways a single big move may be preferable, and we may see a relief rally if the move is decisive," said David Bayer, president of Knappenberger Bayer Growth Advisors, a money management firm. Still, stocks were hurt this week as the yield on the 30-year government bond hovered near 19-month highs, indicating bond investors expect the Fed to raise rates by more than 25 basis points or that any rate increase will only be the first of a series. For the week, the Dow Jones Industrial Average fell 2.4 per cent, the S&P 500 dropped 1.4 per cent and the Nasdaq Composite Index rose 0.7 per cent.

Apart from interest rates, investors will be scrutinising new economic releases, including the June employment figure to be released next Friday. "Investors look at the jobs number as a gauge of economic activity," said Michelle Clayman at New Amsterdam Partners. "If the Fed jacks rates just a quarter point, and then we see an incredibly strong job number, investors will say there is another 25-basis-point increase coming."

In 1994, when the Fed raised rates six times starting in February, the Dow barely eked out a 2.1 per cent gain for the year. Interest rates are not the only thing on investors' minds. Some are looking at the outlook for second-quarter profits. "Two converging events are the Fed meeting next week and, in the next two to three weeks, the battle of interest rates versus earnings," said Marian Pardo, manager with JP Morgan Investment Management.