Federal Reserve Chairman Alan Greenspan virtually declared victory over both inflation and the risk of recession yesterday and said "the economic outlook is, on balance, encouraging" for a period of modest growth with prices well under control through 1996.
Financial markets, which had plunged Monday on warnings about prospects for technology stocks, nose-dived harder yet after microprocessor leader Intel Corp. reported disappointing earnings. Then Mr. Greenspan's upbeat morning report to Congress broadened the rout to other stocks and to bonds, though an afternoon rally trimmed some of the worst losses.
The Dow Jones industrial average, which had lost 50.01 points Tuesday, was down by more than 130 points late yesterday morning and ended the day down 57.41, to close at 4,628.87.
The technology-laden Nasdaq composite index lost 35.66 points -- about 3.61 percent of its value -- to close at 952.87. Long-term interest rates soared, as the yield on the benchmark 30 1/4 -year Treasury bond leaped nearly a 10th of a percentage point to close at 6.86 percent, having been around 6.5 percent only last week.
Big institutional investors apparently concluded that they had let the Fed's July 7 quarter-point cut in short-term interest rates mislead them into hoping for easier money sooner than Mr. Greenspan now seems likely to permit, analysts said.
"The markets had leaped to some unrealistic expectations of how much the Fed was likely to cut, and how soon, and now the markets are becoming more realistic," said Alfred G. Smith III, chief economist for NationsBank Corp.
Markets had "worked up a considerable bubble" in the two weeks since the Fed trimmed the federal funds rate, which banks pay each other for overnight loans, to 5.75 percent, he said.
"I take Greenspan's testimony today as meaning that there is certainly no pressing need to ease further any time soon, but also as leaving the door open to an eventual cut," Mr. Smith said.
"More recent evidence suggests that we may have passed the point of maximum risk" of a recession, though some risk remains, Mr. Greenspan told the House Banking Committee in a legally required twice-a-year appearance.
Virtually declaring that the Fed is about to achieve its long-sought "soft landing," the chairman said the spring slowdown appears to have bottomed in June and that the most likely outlook now "is for an upturn in the growth rate . . . over the rest of this year and a moderate pace of expansion next year."
At the same time, "considerable progress toward price stability has occurred" since the Fed engineered six rate increases between February 1994 and February 1995, so the central bank does not rule out possible further rate cuts later in the year if inflation remains subdued, he said.
The rout in technology stocks, which had led the market to spectacular gains in the first half of the year, broadened and deepened yesterday as the market digested Intel's earnings disappointment.
Intel stock has plunged 17 percent in two days, from $78 Tuesday to $65 late yesterday. It set a Nasdaq record for single-day trading in one company, turning over 55.8 million shares yesterday.
"It's not unusual to retrace a bit of where you've gone after the powerful kind of run technology stocks have had this year, but it's also true that we're now trading about where we were only two weeks ago, and it's natural that big market factors like Microsoft and Intel will have a ricochet effect," said Stephen C. Dube, a technology analyst for Wasserstein Perella Securities. "But I wouldn't want to say this is a buying opportunity, either."
"I look at this as a bull market correction that will enable technology stocks to move forward again in the longer run," said John Marren, senior technology analyst at Alex. Brown & Sons Inc., which helped to trigger Intel's nose-dive yesterday morning by downgrading the stock from "strong buy" to "neutral" based on the earnings it reported Tuesday.
The technology rout was "broadened into other sectors and exaggerated in technology stocks" when long-term interest rates in the bond market, drifting upward for several days, spiked up in response to Mr. Greenspan's report, he said.
Though the bond market is currently pulling back after nearly eight months of steady gains, "I still see the eventual equilibrium point in long-term interest rates as something much closer to 6 percent than to 7 by the end of this year," NationsBank's Mr. Smith said.
"From an economic standpoint, I am still constructive on the stock market's medium-term direction, but from a trading standpoint, I'd be very, very cautious over the next few days," Mr. Smith said.
". . . Now there appear to be a lot of people with a lot of firepower taking bearish positions, coming into the market and taking short positions and derivative positions in important stocks in the last few days, and I don't think it would be a good idea to go up against that right now."