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Stocks jump over US Fed low rate pledge
Federal Reserve promises to keep interest rates near zero for almost three more years.
Last Modified: 26 Jan 2012 11:29
The Fed's extension of low rates signals that it expects inflation to stay low [Gallo/Getty]

The stock has market bounced to its highest close since last spring after the Federal Reserve pledged to keep interest rates near zero for almost three more years.

Bond yields dropped sharply, then climbed back later in the day on Wednesday when investors began looking more closely into the Fed's deliberations. The yield on the five-year Treasury note touched an all-time low.

The big moves in both markets came at 1730 GMT, when the Fed's monetary policy committee said it was unlikely to raise interest rates before late 2014.

Low rates

The Fed cut rates to near zero in December 2008, during the financial crisis, and has held them there ever since. The announcement was a sign that the Fed expects the economy, which is improving, to need significant help for three more years.

The Dow Jones industrial average was down as much as 95 points in the morning and about 60 points before the Fed announcement. It shot to a gain of 103 points during the afternoon.

In the bond market, the yield on the 10-year Treasury note was at 2.05 per cent an hour before the announcement and quickly fell to 1.92, a significant move. It rose to 1.99 per cent two hours later.

The bounce-back happened at about 1900 GMT, when the Fed released details of how the committee voted.

Six of its 17 members had favoured an interest rate increase this year or next - well before late 2014 in either case.

The yield on the five-year Treasury note hit 0.76 per cent, an all-time low. Bond yields fall when their prices rise.

The Fed's extension of low rates signaled that it expects inflation to stay low.

'It's a coin flip'

The announcement guaranteed that short-term loans will remain cheap, making it easier for investors to finance longer-term purchases, said John Canally, investment strategist and economist for LPL Financial.

Monetary decisions by the Fed can change the market's momentum in the short term but rarely have a longer-term impact, Canally warned.

The market changed directions after 22 of the past 24 Fed policy announcements, he said, yet the change evaporates quickly. The market essentially has an equal chance of rising or falling in the five days after Fed meetings, he said.

"It's a coin flip, really," Canally said.

Keeping rates ultra-low for a longer period increases the likelihood that the Fed will engage in more bond-buying programmes to help the economy, a policy known as quantitative easing, said Anthony Chan, chief economist with JPMorgan Private Wealth Management. Those tend to boost bond prices by increasing the overall demand in the market.

Chan called the Fed's move insurance against the European debt crisis and a recession across the Atlantic Ocean. Stock buyers, he said, were happy about the prospect of low inflation and a Fed leaning towards promoting economic growth.

The promise of lower rates pushed the dollar lower against other major currencies. Low interest rates make the dollar less attractive because they reduce the returns traders get on US debt and other bonds priced in dollars.

Source:
Agencies
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