Stocks volatile after Fed cut

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The Federal Reserve, in second cut in a week, slashes key interest rate by half-percentage point. Play video

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NEW YORK (CNNMoney.com) -- Stocks slipped Wednesday, erasing gains late in the session following a rally sparked by the Federal Reserve's decision to cut a key short-term interest rate by a half-percentage point, as expected.

The Dow Jones industrial average (INDU) lost 0.3%. The broader Standard & Poor's 500 (SPX) fell 0.5% and the Nasdaq composite (COMP) lost 0.4%.

Stocks had rallied until the last half hour of trade, with the Dow at one time up nearly 200 points, as investors welcomed news that the Federal Reserve cut interest rates by a half-percentage point, as expected.

But the advance sputtered near the close, with stocks ending lower, following market rumors that one of the major bond insurers was likely to be downgraded. The latest panic about the credit market crisis has further complicated the outlook for bond insurers such as Ambac Financial (ABK) and MBIA (MBI). (Full story).

Ahead of the Fed meeting, stocks had fallen on a weaker-than-expected fourth-quarter GDP report and Yahoo's weaker profit forecast.

The day's action reflects the ongoing whipsawing investors have been facing as they have sought to digest sometimes conflicting news about the economy, said Chris Johnson, chief investment officer at Johnson Research Group.

"The Fed move today was seen as something that was needed," Johnson said. "But this is a market that's not going to resolve itself so quickly."

He said that the psychology remains negative enough that Wall Streeters are going to sell into strength, which is going to limit the capacity of any rallies for the time being.

After the close, Amazon.com (AMZN, Fortune 500) reported higher quarterly earnings that met estimates on higher revenue that topped estimates.

Also after the close, Starbucks reported higher quarterly profit that topped estimates, but also said that it will open less new U.S. stores in 2008 and close some underperforming ones amid the consumer spending slowdown. Starbucks (SBUX, Fortune 500) stock fell more than 3% in extended-hours trading. (Full story).

The Fed cuts rates. The central bank lowered the fed funds rate by a half-percentage point to 3% as expected. The fed funds rate is an overnight bank lending rate that affects consumer loans. The Fed also cut the discount rate, which affects bank loans, by a half-percentage point to 3.5%. (Full story)

Last week, the Fed cut both the fed funds and discount rates by three-quarters of a percentage point, amid deteriorating economic conditions in the wake of the housing and credit market crises.

Those deteriorating conditions had sent U.S. and global markets slumping on fears that the economy is in a recession, or is in danger of falling into one.

In the Fed's closely-watched statement, the central bankers said that "financial markets remain under considerable stress, and credit has tightened further for some businesses and households." The bankers also said that recent info suggests the housing market contraction is worsening and the labor market continues to soften. (Read the statement).

The half-percentage point cut was what the market expected, which is why stocks initially rallied, said T.J. Marta, chief economic strategist at RBC Capital Markets.

"These are troubled times and the Fed needs to be doing what it's doing although it's not going to necessarily be enough to fix all the problems," Marta said.

He said that the Fed is fighting a credit crisis as much as an economic one, and that while lowering monetary policy will help, it's "not a silver bullet."

What Wednesday's action should do longer-term is "provide a shot in the arm for the confidence of business and consumers," said Georges Yared, chief investment strategist at Yared Investment Research.

However, he said it's going to take some time for the Fed's action to work its way through the system.

Economic news. Fourth-quarter growth was anemic, the government reported Wednesday. GDP growth slowed to an 0.6% annualized rate in the quarter, down from 4.9% in the third quarter, and short of forecasts for a rate of 1.2%.

Another report, from payrolls services firm ADP, showed that private sector employment grew more than expected in January, growing by 130,000 versus forecasts for 40,000. The report could be a good indicator for Friday's broader monthly labor market report.

Earnings news. Yahoo (YHOO, Fortune 500) warned that 2008 revenue could miss the high end of analysts' current forecasts and said that it will cut 1,000 jobs in February. The search engine also reported higher earnings that topped estimates on higher revenue that met estimates. However, investors focused on the negative, sending shares 8.5% lower. (Full story).

Merck reported a steep loss in the fourth quarter due to charges associated with a settlement over its withdrawn painkiller Vioxx. Excluding those charges, Merck reported a quarterly profit that topped estimates. The company also reported higher revenue that missed analysts' forecasts. Merck (MRK, Fortune 500) shares fell 2.8%.

Fellow Dow component Altria (MO, Fortune 500) reported lower quarterly earnings that nonetheless topped estimates. The company also said it will spin off its international tobacco business. Shares gained modestly.

A third Dow component, Boeing (BA, Fortune 500), reported improved quarterly profit that topped forecasts and said 2008 earnings would top earlier forecasts.

UBS (UBS) warned that its will report a steeper-than-expected fourth-quarter loss and take a $14 billion writedown largely due to bad mortgage bets. UBS shares ended lower after a volatile session.

Flextronics (FLEX) reported higher fiscal third-quarter earnings that topped forecasts, boosting the stock by 12.5%.

Market breadth was negative. On the New York Stock Exchange, losers beat winners 9 to 7 on volume of 1.80 billion shares. On the Nasdaq, decliners topped advancers 4 to 3 on volume of 2.6 billion shares.

Other markets. Treasury prices slipped, raising the yield on the 10-year note to 3.68% from 3.67% late Tuesday. Bond prices and yields move in opposite directions.

In currency trading, the dollar fell versus the yen and the euro.

U.S. light crude oil for March delivery rose 69 cents to settle at $91.64 a barrel on the New York Mercantile Exchange. Oil prices had eased off highs following the release of the government's weekly supply report, which showed crude oil and gas stocks rose more than expected.

COMEX gold for April delivery fell $4.50 to $926.30 an ounce, after hitting an all-time trading high of $933.50 Tuesday.