Stocks Continue to Waver at the Flat Line

Updated from 2:13 p.m. EDT

U.S. stocks were mixed in an erratic session Tuesday as traders were dealing with a hawkish speech from the Federal Reserve chief, a leaping dollar and an encouraging development in the blistering oil market.

The Dow Jones Industrial Average got a substantial bump this afternoon, then stumbled back to the flat line before floating 35 points higher at 12,315. The index enjoyed particularly strong support from financial components Citigroup ( C), JPMorgan Chase ( JPM) and AIG ( AIG).

Broader indices, meanwhile, returned to negative territory following a bit of short-lived strength earlier, though both were off their lows for the day. The S&P 500 was down 2 points to 1362, and the Nasdaq Composite lost 9 points to 2450.

"The market is undergoing a state of real nervousness here," said Peter Cardillo, chief market economist with Avalon Partners. "The fact that Fed chairman Ben Bernanke and other Fed members are continually talking about the risks of higher inflation and hinting that the Fed is going to have to raise interest rates to combat inflation, I think, is really weighing heavily on stocks."

As the new day began, traders were digesting with a speech from leader of the central bank, who said the jump in oil costs "has added to the upside risks for inflation and inflation expectations," even as his expectations for a "substantial downturn" have simultaneously diminished. He added that the Fed "will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation."

At the same time, Dow Jones quoted Dallas Fed President Richard Fisher as saying he is forecasting "anemic" growth, but not a recession, and Reuters said the official would be willing to accept a slower economy if that meant inflation would be contained. Also, the Boston Fed's Eric Rosengren reportedly said inflation was running at an "undesirable" level.

Those comments would appear, once again, to suggest that the Fed won't cut interest rates again following its 325-point easing campaign over the past few months. In fact, fed-funds futures today were pricing in roughly 56% odds that the Fed will raise rates at its Aug. 5 gathering. The chances of a quarter-point hike by the September meeting are now set at 100%, and the prospect of a 50-basis-point climb by October is fully priced in.

Meanwhile, crude oil earlier soared to a new high shy of the $138 mark, but reversed to slide $3.04 at $131.31 a barrel after news broke that Saudi Arabia's oil output was boosted by nearly 500,000 barrels a day this quarter at 9.54 million, according to CNBC. The network cited sources in the Saudi Oil Ministry.

Higher oil prices were among the main factors driving up April's U.S. trade deficit, or the amount by which imports outweighed exports, to $60.9 billion. Analysts were looking for minus $60 billion, and that compares with March's upwardly revised figure of negative $56.5 billion.

"The trade deficit heightens the risk of recession and surging unemployment," wrote Peter Morici, a business professor with the University of Maryland and former chief economist at the U.S. International Trade Commission. "Ben Bernanke's most recent comments about oil-driven inflation only serve to distract attention from these issues and aggravate risks."

"Bernanke in recent comments has emphasized that western central banks stand ready to resist oil-induced recession, when in fact oil price increases are far beyond the control of the Federal Reserve and other central banks to affect," Morici continued. He added that the Fed chief's words "cause markets to believe the Fed will raise interest rates as we travel into a recession and this drives equity prices down, compounding the panic created by rising oil prices."

Following Bernanke's observations, the U.S. dollar jumped by more than a percent against the euro, the yen, and the pound and barreled 1.6% higher against the Swiss franc.

Gold futures slid $23.50 to $871.20 an ounce.

Foreign markets were uniformly lower, and one of the hardest hit was China's CSI 300, which plummeted 8.1%. The Nikkei 225 in Tokyo dropped 1.1% overnight, and the Hang Seng Index in Hong Kong sank 4.2%. Among European exchanges, London's FTSE 100, Germany's Xetra Dax and the Paris Cac were all down 0.7% or more.

On the U.S. corporate front, chipmaker Texas Instruments ( TXN) narrowed its second-quarter outlook, partially citing weak demand for handheld devices. Shares were falling 2.4%.

Elsewhere, both Citigroup and Lehman Brothers bumped up their Apple ( AAPL) price targets a day after the company released its 3G-enabled iPhone, after which the stock added 2.5%.

Separately, shares of Lehman Brothers ( LEH) tumbled 7.8% after Wachovia downgraded the stock to market perform from outperform.

Kirk Kerkorian's Tracinda said its offer to buy up to 20 million shares of Ford ( F) generated a tremendous response, with more than 1 billion shares of the automaker being tendered. However, Tracinda will keep to its plan to limit the purchase to 20 million, spending $170 million overall. Ford shares slumped 3.8%.

Yields on government bonds forged higher as investors pulled out of Treasury securities. The 10-year note was down 26/32 in price to yield 4.10%, and the 30-year bond shed 1-3/32 in price, yielding 4.70%.

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