Stocks Drop After Fed Fails To Calm Credit Worries

NEW YORK (MarketWatch) - Stock prices dropped after the Federal Reserve opted to leave interest rates untouched and reiterated the central bank's primary concern to be inflation.

"The initial reaction was clearly negative, and the reason is because the Federal Reserve did not go far enough in the view of investors in focusing its concern on credit market conditions and the impact on the economy," said Hugh Johnson, chairman of Johnson Illington Advisors.

The Dow Jones Industrial Average fell 66.9 points to 13,401.3, with 19 of its 23 components on the decline, with Boeing Co. and American Express Co. among the stocks fronting the Dow's losses.

Boeing fell 1.6%, while American Express was off 1.2%.

The S&P 500 dropped 2.5 points to 1,465.14, while the Nasdaq Composite was 13.38 points lower at 2,533.95.

Trading volume showed 1.4 billion shares exchanging hands at the New York Stock Exchange and 1.8 billion shares trading on the Nasdaq stock market. Advancing issues topped decliners 5 to 3 on the NYSE, and by 17 to 13 on the Nasdaq.

"The market will probably sell-off because there were some built-in expectations that they might move closer to a neutral stance," where risks to inflation and growth are equal, said Owen Fitzpatrick, head of the U.S. equity group at Deutsche Bank.

As expected, the central bank left the key overnight rate at 5.25% for the ninth straight meeting, while repeating the risk that inflation will fail to moderate is the "predominant policy concern."

Many investors had expected recent problems in the credit markets would force the Fed to note concern about an economic slowdown in its policy statement. For many months the Fed's top worry has been inflation.

Such a change in stance could pave the way for a rate cut in coming months.

Automaker General Motors Corp. fronted the Dow's advancing stocks, gained 2.3% after GM said it completed the sale of its Allison Transmission commercial and military business to the Carlyle Group and Onex Corp. for about $5.6 billion.

Shares of leading U.S. banks and brokerage firms gained, with the stock of insurer Assurant Inc. up 4.2% after analysts at Merrill Lynch upgraded Assurant to buy.

Bear Stearns Cos. gained 3.1% higher after slipping earlier on after Bloomberg News reported the company's decision to liquidate two bankrupt hedge funds in the Cayman Islands instead of New York might limit creditors' and investors' ability to get their money back.

Lehman Bros. analysts began coverage of private-equity and hedge fund Blackstone Group , giving it an overweight rating. Blackstone's shares gained 3.5%.

Luminent Mortgage Capital Inc. was cut to sell from neutral by UBS. Its stock was off about 81.7%. The lender suspended its quarterly dividend and said it would explore options including a sale.

Fed factor

Earlier, the Labor Department reported that productivity in the second quarter rose 1.8%, below the 2.1% gain expected by economists polled by MarketWatch.

The wages and benefits component of the report suggested inflation may remain worrisome. The department said that unit labor costs - a key inflationary signal - rose at an annual rate of 2.1% in the second quarter. Economists had expected a 1.6% gain.

Other market moves

Treasury prices were mildly higher as the market awaited the Fed's interest rate decision, with the benchmark 10-year Treasury note up 1/32 at 98 5/32, yielding 4.738%.

The dollar rallied against European currencies after a government report showed a larger-than-expected rise in unit labor costs - an indication of inflation. In New York trade, the dollar was quoted at 118.34 yen, compared with 119.03 yen late Monday. The euro stood at $1.3762, compared with $1.3793.

Gold futures edged lower, with Gold for December delivery ending $1 lower at $682.30 an ounce on the New York Mercantile Exchange. br>
Crude-oil futures extended their losses, weighed down by technical selling, weakness on Wall Street and ongoing concern that an economic slowdown will lower energy demand. Crude oil for September delivery fell 63 cents to $71.43 a barrel on the New York Mercantile Exchange.

On Monday stocks staged a strong comeback, after suffering a rout at the end of last week when investors dumped shares on fears the credit crunch is spreading throughout the economy.

By Kate Gibson