Treasuries rallied with U.S. stocks, while the dollar tumbled to a three-week low after the Federal Reserve decided against curtailing stimulus that has helped propel the third-longest bull market since World War II.
The Standard & Poor’s 500 Index extended earlier gains as Fed Chair Janet Yellen reiterated that the path of any future increase was likely to be gradual. Two-year note rates tumbled the most in six months, while the greenback sank to a three-week low. Emerging-market equities gained.
“It’s a little bit of a dovish development here,” said Omer Esiner, chief market analyst at currency brokerage Commonwealth Foreign Exchange Inc. in Washington. “The actual outcome was not a major surprise, but I think the statement was somewhat more dovish than I was expecting.”
In holding their benchmark federal funds rate at zero to 0.25%, policy makers showed they are still not convinced inflation will move gradually back to their 2% target, despite continued gains in the labor market.
The decision keeps in place the record-low borrowing costs that have helped propel stocks higher by nearly 200 percent 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% this year through Wednesday after three years of double-digit gains.
“Yellen wants to make sure that the U.S. remains the driver of global economic health,” said Dan Veru, who helps oversee $5 billion as chief investment officer at Fort Lee, N.J.-based Palisade Capital Management. “The U.S. has to be the engine for pulling the globe out of slow growth, so doing anything that creates a headwind superseded the fact that we really don’t need rates at zero.”
At 5.1%, U.S. 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% plunge in energy costs over the past 12 months and a rising dollar.
“It doesn’t seem like it’s taken the market by surprise,” Russ Koesterich, a global chief investment strategist at BlackRock Inc., the world’s largest money manager, said after the announcement. “I think what happens now is the market turns its attention to the economic activity and in short order, third-quarter earnings.”
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.
The decision to keep rates near zero wasn’t a surprise given the weakness on U.S. equity markets. 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% decline since 2011. The Fed has never started tightening within a month of a correction.
Market anxiety has been elevated amid concern that higher U.S. rates could rattle emerging markets and threaten global growth. Price swings on the S&P 500 have widened to 1.5% a day in the past month, compared with 0.6% 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 VIX fell 7% to 19.86 Thursday.
