A sharp rise in manufacturing in the United States Friday initially sent stock prices higher, but then the market fell off significantly because of fears that a fast growing economy could lead to higher interest rates.
A private measure of manufacturing in December registered its biggest increase since 1950. It was the sixth straight month that the Institute for Supply Management's factory index posted an increase.
But financial market participants fear that higher activity in the manufacturing sector may boost economic growth to the point where the central bank will feel the need to boost interest rates, currently at a 40 year low. The stock market lost all of its earlier gains by the close.
John Silvia, chief economist at Wachovia Bank in Charlotte, North Carolina, expects interest rates to rise by up to one and one half percentage points within 18 months. Mr. Siliva says if the dollar loses more value against the euro, interest rates could rise even higher.
"If foreign investors perceive significant dollar weakness going forward, combined with an unwillingness at the federal government level to restrain government spending that's the dangerous combination you're looking for that raises the risk that, yes, interest rates could be much higher," he said.
The dollar has lost about 15 percent of its value against the euro in the past year. That decline could help reduce the U.S. trade deficit and give a further boost to the manufacturing sector. The U.S. economy is growing at a four to five percent annual rate.
The stock market reversal Friday was related to a sharp rise in interest rates on two-year government securities. The futures market in Chicago is considered an early indicator of later central bank action on short-term rates. The overnight federal funds rate in the United States is at a historic low of one percent. Inflation exceeds two percent. Some experts worry that if official interest rates - those controlled by the Fed - rise, stock market prices which soared 30 percent over the past year could fall back.