US stocks erase rally as Fed fuels concern on global economy, dollar dives

NEW YORK (BLOOMBERG) - A rally in the Standard & Poor's 500 Index melted away and the US dollar tumbled as the Federal Reserve's decision to keep interest rates near zero per cent raised questions about the strength of the global economy.

The Fed kept its policy interest rate unchanged, showing reluctance to end an era of record monetary stimulus in a time of market turmoil, rising international risks and slow inflation at home. While chair Janet Yellen said most officials still expect a rise in rates this year, she reinforced that the path of higher borrowing costs would be gradual.

"It's a bit of a tussle," said Carin Pai, director of equity strategy at Fiduciary Trust Company International in New York. Her firm manages US$17.4 billion. "If they don't raise rates and continue to hold off on raising rates, what does that say about the economy? That it's not strong enough to withstand an interest rate increase. That's what the market is grappling with right now."

The Standard & Poor's 500 Index fell 0.1 per cent at 3:51 p.m. in New York, reversing a gain of as much as 1.3 per cent. The Dow Jones Industrial Average slipped 36.25 points, or 0.2 per cent, to 16,703.70. The Nasdaq Composite Index added 0.2 per cent. Stocks most sensitive to interest rates had the largest moves, with utilities and real-estate companies advancing more than 1.2 per cent while banks lost 2.4 per cent.

The US dollar sank after the release of the Fed statement, trading about 1 per cent lower against the euro. The dollar index, which measures the greenback against six major peers, was down 0.83 per cent at 94.626 in late trading.

The decision to stand pat on rates keeps a pillar of the bull market in place, as record-low borrowing costs have helped propel stocks higher by nearly 200 per cent in the past 6 1/2 years.

It also amplifies uncertainty about the strength of the American economy at a time financial markets have been roiled by concern that a slowdown in China will spread. The S&P 500 had fallen 3.1 per cent this year through Wednesday after three years of double-digit gains.

At 5.1 per cent, US unemployment is the lowest in seven years and housing sales are rebounding, giving ample evidence that the economy is finding firmer footing. But inflation has remained below the objective of Fed policy makers amid a 51 per cent plunge in energy costs over the past 12 months and a rising dollar.

"Yellen wants to make sure that the US remains the driver of global economic health," said Dan Veru, who helps oversee US$5 billion as chief investment officer at Palisade Capital Management. "The US has to be the engine for pulling the globe out of slow growth."

The argument against tightening got a boost from concern that, with central banks from Asia to Europe considering adding stimulus, any Fed move would have fueled a rally in the greenback. A stronger dollar may crimp profits at exporters at a time when analysts forecast earnings at S&P 500 companies will fall in the final two quarters of 2015.

"Now that this is behind us, people are going to start focusing more on the problems that caused the correction in August, which is weakness in China and other emerging markets and a rough time on the earnings front," said Matt Maley, an equity strategist at Miller Tabak & Co LLC in New York.

The decision to keep rates near zero wasn't a surprise given the weakness on US equity markets. In four tightenings since 1990, including the tapering of bond purchases announced in 2013, the S&P 500 had posted positive returns over the prior three and six month periods, and was within 3 per cent of the gauge's 52-week high, according to a Bank of America Corp. report.

By comparison, the benchmark index was down 4.8 per cent over the last three months through yesterday and 6.4 per cent below its high of 2,130.82 reached in May. The S&P 500 has alternated between gains and losses for the past nine weeks, a streak of indecision that's happened only three times in 20 years, according to data compiled by Bloomberg.

Thursday's rate decision is being received in a market where the role of computers has grown drastically since the last time the Fed raised rates. With high-frequency firms accounting for about half of trading in the US, daily volume has tripled since the early 2000s and now regularly tops 6 billion shares.

The market has whipsawed since China's shock devaluation of its currency on Aug 11, a move that sent the S&P 500 to its first 10 per cent decline since 2011. The Fed has never started tightening within a month of a correction.

Market anxiety has been elevated amid concern that higher US rates could rattle emerging markets and threaten global growth. Price swings on the S&P 500 have widened to 1.5 per cent a day in the past month, compared with 0.6 percent this year through July.

The Chicago Board Options Volatility Index endured its biggest weekly gain on record in August, and has closed above 20 for 18 straight sessions, the longest stretch since June 2012. The gauge rose 0.4 per cent to 21.43 on Thursday.