Rattled Wall Street gives up gains

A Federal Reserve official’s warning about a possible resumption of interest rate hikes unnerved Wall Street today, wiping out an early advance and leaving stocks narrowly higher by the close.

The comments by Chicago Fed President Michael Moskow rattled investors looking to revive last week’s rally after they collected profits on Monday.

Retailers, along with other sectors dependent on consumer spending, were among the stocks causing the major indexes to wobble on Tuesday.

The Fed left interest rates unchanged earlier this month after raising them 17 times in a row.

Wall Street has rallied since then on hopes this would be the end, but one analyst said Moskow’s comments could be “putting out a trial balloon” to gauge the market’s reaction to a continuation of rate hikes.

“The market has discounted the likelihood of another rate increase by about a 20% chance for the next meeting” in September, said Scott Merritt, a US equity strategist for JPMorgan Asset Management. “He might want to get that up to 50% to get more flexibility. If expectations get too high or low, (Fed Chairman Ben) Bernanke can’t really go against it or he’ll lose credibility.”

The Dow Jones industrial average dipped 4.89, or 0.04%, to close at 11,340.16 after being up more than 38 points early in the session. Advancers beat decliners on the New York Stock Exchange and the Nasdaq Stock Market.

Broader stock indicators edged higher. The Standard & Poor’s 500 index rose 1.30, or 0.10%, to close at 1,298.82, and the Nasdaq composite index gained 2.27, or 0.11%, to end at 2,150.02.

The market initially ramped up after Iran’s top nuclear negotiator committed to “serious negotiations” over its nuclear ambitions, giving hopes that Middle East tensions might ease.

And gains from Advanced Micro Devices Inc. and XM Satellite Radio Holdings helped send technology stocks higher.

Bonds held their ground, with the yield on the benchmark 10-year Treasury note falling to 4.81% from 4.82%. The dollar maintained its gains against other major currencies, while gold prices edged lower.

The 10-year treasury yields have been trading near their lowest in five months, inspired by data last week that indicated the Federal Reserve’s attack on inflation was working. Several economic reports issued last week – including one that showed benign inflation data – help convinced investors the economy was headed toward a “soft landing”.

Wall Street wants the economy to slow so inflation is contained but still grow enough to keep corporate profits strong. Moskow’s comments helped reverse the effects of last week’s hopes.

Among the decliners were high-end retailers such as electronics chains, which could see sales curbed if higher rates spawn a drag on consumer spending. Circuit City Stores shed 80 cents, or 3.2%, to 24.20, while rival Best Buy fell 76 cents to 46.90.

An Advanced Micro Devices executive said the world’s No 2 chip maker behind Intel hopes to capture 40% of the global market for computer processors by 2009. Shares of the company, which was upgraded by Bear Stearns, advanced 1.48, or 6.3%, to 24.88.

Investors also were encouraged that Toll Brother’s full-year guidance was not a worst case scenario amid a US housing slump. The luxury homebuilder posted a 19% drop in third-quarter profit, but that still surpassed projections and lifted the stock.

Toll Brothers added 43 cents to 25.20. Rival Pulte Homes, the US’s largest homebuilder, picked up 14 cents to 29.11.

Advancing shares outnumbered decliners by nearly 4 to 3 on the New York Stock Exchange, where volume totalled 1.22 billion shares, up from Monday’s 1.12 billion.

The Russell 2000 index of smaller companies rose 2.43, or 0.34%, to 707.76.