Dow Jumps on Fed Announcement


The Dow Jones Industrials Average jumped nearly 1% on the Federal Reserve's announcement that it's going to continue the current pace of its economic stimulus efforts. The broader S&P 500 Index rose 1.2%.

Although the hype surrounding Fed announcements can sometimes be a bit overplayed because short- and medium-term traders are much more sensitive to changes in Fed policy than are long-term investors, monetary policy decisions do have implications for the economy.

The Fed is trying to balance its twin-policy goals of low unemployment and stable inflation. In its statement today, the Fed noted the pace of the recovery was especially impressive considering the damage done by federal budget cuts, but decided to wait a bit longer to make sure that economic progress would be sustained before beginning to withdraw its support.

What's the big picture like?

Inflation is still below the Fed's 2% target:

Source: Federal Reserve.

Unemployment has fallen considerably, though it still remains well above the roughly 5.2% to 6% range that the Fed cites as a longer-run normal rate of unemployment. However, because changes in Fed policy can take effect gradually, the Fed has said in the past that it will begin gradually winding down its long-term bond buying as unemployment passes the 7%-ish threshold the Fed considers "substantial improvement." The Fed reiterated today that unless future inflation expectations rise, it doesn't plan to begin raising short-term rates until unemployment falls below 6.5%.

Source: Federal Reserve.

Twenty-nine of 30 Dow stocks rose on the announcement, with only UnitedHealth Group continuing its mildly lackluster week. Aside from the gravity of a nearly 40% year-to-date gain that the stock has to contend with, and some questions by investors about how the upcoming January launch of state exchanges will affect insurers. Today, Walgreen announced that it plans to move 160,000 employees who'd previously been covered by Blue Cross Blue Shield or UnitedHealth Group onto exchanges. (It's unclear whether Walgreen directly benefits -- it says the idea was to give its employees more choice -- since the company plans to continue making the same premium contributions.)

As you'd expect, cyclical sectors rose sharply today. Utilities, normally thought of as defensive investments, jumped, too, perhaps because of interest from yield-seeking investors in the face of lower expected bond rates. Alcoa jumped nearly 4%, along with non-Dow metal producers such as Vale and BHP Billiton. These types of companies can be extremely sensitive to the economy and interest rates because of their high fixed costs, moderate leverage, and cyclical demand for their products. Alcoa, of course, is slated to be dropped from the Dow to make room for new members. It's been struggling a bit because of weak metal prices since the start of the financial crisis, though demand is expected to increase.

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Ilan Moscovitz has no position in any stocks mentioned. The Motley Fool recommends UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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