'Hallelujah' the Fed swoops in
Wall Street hails central bank's decision to cut the fed funds rate by a half-percentage point; Dow sees best one-day point gain in nearly 5 years.
NEW YORK (CNNMoney.com) -- Stocks rallied Tuesday after the Federal Reserve cut a key short-term interest rate by a half-percentage point, reassuring investors that it was taking aggressive action amid the credit and mortgage market meltdown.
The Dow Jones industrial average (Charts) jumped roughly 336 points, the biggest one-day point gain since Oct. 15, 2002, when the Dow added 378.28 points. On a percentage basis, the Dow added 2.5 percent, its best one-day gain since April 2, 2003, when it gained 2.67 percent.
"The market reaction is pretty clearly 'Hallelujah'," said Stuart Hoffman, chief economist at PNC Financial Services Center.
Treasury prices slipped, lifting corresponding yields.
Oil prices closed at a record high for a second session. Gold prices surged to a 27-year high, reflecting a similar run in other commodity prices after the Fed announcement.
Wednesday morning brings the release of the August consumer price index (CPI), August readings on housing starts and building permits, and the weekly oil inventory report.
The Federal Reserve voted to cut the fed funds rate by a half-percentage point to 4.75 percent. It was the first time the central bank had cut the fed funds rate since June 2003.
Most stock market participants were expecting a cut, with the disagreement about whether the cut would be 25 basis points, or a quarter-percentage point, or 50 basis points, or a half-percentage point. There are 100 basis points in one percentage point.
"This is a good first move that will give aggressive confidence and aggressive relief to the credit markets and the consumer," said Georges Yared, chief investment strategist at Yared Investment Research. "It's good that they didn't do this incrementally, 25 points at a time."
The Fed also cut the discount rate for the second time in a little over a month, lowering the largely symbolic rate by a half-percentage point.
The fed funds rate, which determines consumer loans, had stood at 5.25 percent for more than a year, as the Fed sought to balance inflationary pressure with the threat of an economic slowdown sparked by the housing market collapse.
But the recent rise in mortgage defaults and the tightening of credit raised expectations on Wall Street that the central bank would cut interest rates to help protect the economy and to keep financial markets stable.
The decision Tuesday seemed to reassure investors that the central bank will do what it can to keep liquidity flowing and try to protect the economy from falling into a recession.
The accompanying statement said that although economic growth was moderate in the first half of the year, the tightening of credit conditions could intensify the housing correction and drag on growth going forward.
The bankers said the cut was intended to "help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time." (Read the full statement here.)
"Reading between the lines, the tone of the statement is that the door is still wide open for cuts in the fed funds and discount rates at upcoming meetings," said Hoffman.
Hoffman said he can't imagine that the year will end with the fed funds rate at 4.75 percent, where it stands today. He said that it will end the year at least 25 or 50 basis points lower.
Stock gains were broad based, with 29 out of 30 Dow stocks rising, led by financial components JP Morgan (Charts, Fortune 500), American Express (Charts, Fortune 500) and Citigroup (Charts, Fortune 500).
The financial sector has been hit hard in the recent turmoil and will benefit from the day's Fed action.
The sector also got a boost from Lehman Brothers (Charts, Fortune 500), which reported a narrower-than-expected decline in quarterly income thanks to its investment banking and management units. The strength in those areas tempered losses in its fixed-income unit, which was hit by the impact of the subprime mortgage fallout and credit market crisis.
On a more negative note, discount brokerage E-Trade (Charts) cut its profit outlook late Monday, saying tighter credit conditions will force it to get out of businesses that don't deal directly with retail investors.
Beyond the financial sector, other gainers included economically-sensitive issues, such as Alcoa (Charts, Fortune 500) and Caterpillar (Charts, Fortune 500), along with stocks sensitive to consumer-spending trends, such as Wal-Mart Stores (Charts, Fortune 500) and Walt Disney (Charts, Fortune 500).
Among other movers, Best Buy (Charts, Fortune 500) climbed 6.6 percent after the electronics retailer reported quarterly sales and earnings rose from a year earlier and topped forecasts, thanks to strong sales and a stock buyback program.
Market breadth was positive. On the New York Stock Exchange, winners beat losers by more than 8 to 1 on volume of 1.65 billion shares. On the Nasdaq, advancers beat decliners by more than 3 to 1 on volume of 2.1 billion shares.
A report Tuesday morning showed that the number of foreclosures jumped in August, reflecting the impact of subprime adjustable rate loans resetting.
On a more positive note, prices paid at the wholesale level fell more than expected in August, according to the Producer Price Index (PPI) released early Tuesday. The so-called core PPI, which strips out volatile food and energy, rose a bigger-than-expected 0.2 percent.
Treasury prices fell, pushing the yield on the 10-year note to 4.47 percent from 4.46 percent late Monday. Bond prices and yields move in opposite directions.
U.S. light crude oil for October delivery rose 94 cents to settle at $81.51 a barrel on the New York Mercantile Exchange, a record closing high for the second session in a row.
However, the record price is still below inflation-adjusted highs hit in the early 1980s, which would be equal to at least $95 a barrel today.
Tuesday's news sparked a knee-jerk positive reaction in stocks. But the forecast could be good longer term as well.
Lower rates have typically sparked broader gains six months after the first cut in a new rate-cutting series, according to a study by Standard and Poor's. (See chart.)
S&P's chief investment strategist Sam Stovall looked at 11 rate-cutting cycles between 1945 and 2001, and found that the S&P 500 rose in 7 of those 11 cycles, for an average gain of 12.3 percent.
Looking out 12 months beyond the first cut, the S&P 500 gained an average of 18.8 percent and rose in 10 of the 11 periods.
The Fed last cut rates in June 2003, when it lowered the fed funds rate to 1 percent, the lowest level in 45 years. It was the 13th cut since 2001, as the central bank tried to protect the economy after the bursting of the tech bubble, the Sept. 11 attacks and the eventual recession.
After a year of holding steady, the Fed began raising rates in June 2004, so as to move away from the unusually low rates of the previous year, and to protect the economy from the threat of higher inflationary pressures. The Fed ended up boosting rates 17 times in a row until it reached 5.25 percent.