The dollar continued to gather strength, hitting a six-month high against the euro after a report showed German business sentiment fell to a three-year low in August, increasing expectations that the economy will tip into a recession.
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World stocks hit their lowest level in nearly two years amid weakening German business sentimentand worries about the financial sector.
Minutes from the Fed's latest meeting indicated that policy makers were concerned about slower consumer and business spending. Most Fed officials didn't think rates were too low given the impact of the credit crunch, the minutes show, but nonetheless see the next direction for rates is probably up.
In economic news, prices of U.S. single-family homes dropped by a record 15.4 percentin the second quarter, thought the monthly rate of decline slowed in June from May. New-home sales rose to an annual pace of 515,000 in July from the 17-year low of 503,000 in June, but still fell short of forecasts. The Conference Board's gauge ofconsumer confidence jumped to 56.9 in August from 51.9 in July, blowing past expectations for a reading of 53.
Financials eked out a gain of about 0.6 percent amid gains in Lehman Brothers, Fannie Mae and Freddie Mac.
Lehman Brothers rose 4.3 percent as speculation continued to swirl about the firm. Private-equity firm Kohlberg Kravis Roberts has a "high level of interest" in buying Lehman's crown jewel, the Neuberger & Berman money-management firm, CNBC reported. Korea Development Bank has also been bandied about as a possible suitor but has raised concerns among Korean regulators.
Merrill Lynch fell 0.4 percent even as the Wall Street Journal reported that the brokerage firm's biggest shareholder has expressed confidence in the firm under CEO John Thain's leadership.
Fannie Mae and Freddie Mac continued to rally amid growing optimism that maybe the stocks won't be wiped out. Fannie has gained more than 12 percent in the past two sessions, while Freddie has rocketed 38 percent.
The home-financing giants said their investment portfolios grew in July but delinquencies reached record levels, pressuring their capital positions. Citigroup said the two probably have enough capital to absorb losses through the end of the year. The companies are currently meeting regulator deadlines for rolling over their debt.
Goldman Sachs said there are probably several things the U.S. Treasury can do before seizing control of Fannie and Freddie, including easing capital demands, buying mortgage securities from the pair or directly injecting capital.
The rally in Fannie and Freddie stock started Monday as a $2 billion debt saleby Freddie triggered some speculation that the firms wouldn't need a bailout.
The FDIC reported that the number of problem banks on its watch list rose to 117 in the second quarter from 90 in the first. Combined assets increased to $78 billion from $26 billion, which indicates that there probably isn't a really big bank on the watch list.
The FDIC doesn't name names but CNBC's Jim Cramer does, listing three banks as potential candidates for failure.
Nine U.S. banks have failed so far this year, the latest of which was Kansas-based Columbian Bank and Trust Co. on Friday.
ExxonMobil gained 1.6 percent, making it one of the biggest gainers on the Dow, due to the rise in oil prices.
Shares of Anadarko Petroleum jumped 6.4 percent after the oil- and gas-exploration company announced a $5 billion stock buyback.
General Motors slipped 0.9 percent after the auto maker said two Gulf Arab investors have expressed interest in buying its Hummer brand.
Rival Ford announced plans to spend $75 million to retool a Michigan SUV plant in order to build more cars and fuel-efficient vehicles.
Ford's manufacturing chief said the auto maker doesn't plan to hire any new entry-level, hourly workers until mid-2009 and that existing workers who have accepted buyouts will be released by year end. Ford has cut its hourly work force nearly in half to 54,000 in the past three years.
There were a couple of downgrades in the tech sector: Marvell Technology declined 6.6 percent after Jefferies cut its rating on the stock to "hold" from "buy," while Broadcom fell 4.8 percent after Oppenheimer lowered its rating to "perform" from "outperform."
Delta Air Lines skidded 5.1 percent after the carrier said it tapped a $1 billion loan ahead of its planned merger with Northwest Airlines and renegotiated its credit-card agreement to ensure revenue is turned over in a timely manner. Northwest shares lost 4.6 percent.
MONDAY-THURSDAY: Democratic National Convention in Denver
TUESDAY: Fed minutes; Census bureau releases 2007 stats; Farmers' Almanac 2009 hits stores, predicts colder winter; Earnings from Smithfield Foods, Big Lots
WEDNESDAY: Weekly mortgage applications; durable goods; Fed's Lockhart speaks; weekly crude inventories; Report from Chicago Fed; Earnings from American Eagle, Dollar Tree
THURSDAY: Jobless claims; GDP, corporate profits; natural-gas inventories; Earnings from Sears Holdings, Tiffany and Dell; Barack Obama's acceptance speech
FRIDAY: Personal income and spending; Chicago manuf. report; consumer sentiment; farm prices
WATCHERS: McCain VP announcement
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