The Federal Open Market Committee not only delivered its 11th consecutive quarter-point rate hike on Tuesday. The central bank also signaled that -- barring strong evidence that the impact of Hurricane Katrina threatened to sink the U.S. economy in coming months -- it will continue lifting interest rates for the foreseeable future, much to the dismay of equity investors. While the market clearly expected the rate hike, many hoped that the Fed would signal more flexibility, opening the door for a pause in the near future. But "the Fed basically told the market not to expect a pause in November," says Banc of America economist Peter Kretzmer. In reaction, stocks fell sharply following the Fed's 2:15 p.m. EST announcement. After trading as high as 10,604.76 earlier in the day, the Dow Jones Industrial Average finished down 76.11 points, or 0.72%, to 10,481.52. Home Depot ( HD), McDonald's ( MCD) and Wal-Mart ( WMT) were among the major drags on the Dow. The S&P 500 dropped 9.68 points, or 0.79%, to 1221.34. The Nasdaq Composite lost 13.93 points, or 0.65%, to 2131.33. On a day dominated by macro news, individuals names such as American Eagle Outfitters ( AEOS) and Tempur-Pedic ( TPX) were notable losers after issuing warnings, while Procter & Gamble ( PG) and Goldman Sachs ( GS) were standouts on the upside. About 2.3 billion shares changed hands on the New York Stock Exchange, with decliners beating advancers by a 2-to-1 margin. Trading volume on the Nasdaq was 1.9 billion shares, with decliners outpacing advancers 3 to 2. The Fed's seemingly inflexible stance also made it harder for investors to face the possibility of another hit to the economy and energy prices -- this time from Hurricane Rita. Hopes that Rita would miss Texas refineries -- and promises of more supply from the Organization of Petroleum Exporting Countries -- led crude oil prices lower Tuesday, originally lending support to stocks. Crude oil finished down $1.16 at $66.23 per barrel.
With crude falling, oil stocks followed suit, even as Prudential, citing higher commodity forecasts, raised its price targets on Anadarko Petroleum ( APC), Burlington Resources ( BR), Devon Energy ( DVN) and Chesapeake Energy ( CHK). The Amex Oil and Gas Index fell 1.1%, and the Philadelphia Stock Exchange Oil Service Index slid 0.8%.
statement accompanying the Fed's decision to lift its fed funds target to 3.75%, the central bank said that Katrina's impact on energy prices -- and the associated volatility in energy markets -- made the near-term economic outlook uncertain. But Katrina's impact does "not pose a more persistent threat," the Fed declared. "Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity," the Fed statement said. The underlying message was that even if some economic deterioration is evident by the time of the Fed's next rate-setting meeting on Nov. 1, this should not be taken as a sign that the central bank will pause, according to Kretzmer. "The widespread devastation in the Gulf region, the associated dislocation of economic activity and the boost to energy prices imply that spending, production and employment will be set back in the near term," the Fed said. But the Fed clearly maintained its belief that monetary policy remained accommodative and reiterated its mantra that this "policy accommodation can be removed at a pace that is likely to be measured." The market now sees a 76% chance of a Fed hike in November compared with 56% before Tuesday's decision, according to fed funds futures. The market is also expecting a 24% chance of a hike at the FOMC's Dec. 13 meeting, compared with 0% previously. While only a handful of equities investors expected a pause at Tuesday's meeting, many others had nourished hopes that the Fed would remove its description of monetary policy as accommodative, signaling a near end to rate hikes, according to Marc Pado, a market strategist at Cantor Fitzgerald.
"There were those that hoped for a pause, and those that expected a rate hike but were hoping to get the light at the end of the tunnel. In the end, no one got what they wanted," Pado says. The strategist noted that disappointment over the Fed's language served as a catalyst for the major indices to fall through their lows of last Thursday, opening the door for the market to potentially retest its August lows of 10,397.29 on the Dow, 1205.10 on the S&P and 2120.77 for the Nasdaq. Meanwhile, prices of Treasuries with longer maturities rose, and their yields fell, on the Fed's commitment to continue fighting inflation. The 10-year Treasury ended the session unchanged while its yield stood at 4.24%. Before the Fed decision, the benchmark note was down 7/32, and its yield stood at 4.27%. Although the Fed did emphasize the inflationary risks stemming from rising energy prices, the central bank noted that core inflation so far remained tame. "We had seen market expectations of inflation gaining ground in recent weeks," says Kretzmer. "That was one of the reasons why the Fed had to raise rates, as those expectations can turn into realities and convince businesses to pass on higher prices." Then again, higher prices were hard to find in the stock market Tuesday.