Fed sparks rally on Wall Street

Major indexes extend gains after the U.S. central bank says it will buy Treasury bonds to increase liquidity.

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NEW YORK (CNNMoney.com) -- Stocks rallied Wednesday, posting gains for their sixth of seven sessions, after the Federal Reserve said it would buy up to $300 billion in long-term government bonds.

The Dow Jones industrial average (INDU) gained 91 points, or 1.2%, to close at 7486, while the S&P 500 (SPX) index advanced more than 2%. The Nasdaq composite (COMP) ended just under 2% higher.

After closing at its lowest level in 12 years on March 9, the Dow has climbed more than 14%, and the S&P 500 has gained 17% over the same period.

Stocks were lower throughout the morning but turned sharply higher after the Fed announced its plan to increase liquidity in the credit markets over the next six months

By purchasing the $300 billion in longer-term Treasurys, the central bank hopes to bring down interest rates on other types of debt tied to the bond market, such as corporate debt and mortgage loans, to ease the flow of credit. The Fed also announced plans to buy an additional $750 billion in mortgage-backed securities.

While the economy is likely to remain weak in the near term, the Fed said it expects the government's efforts to stabilize the financial system to "contribute to a gradual resumption of sustainable economic growth." As was widely expected, the central bank held interest rates steady near 0%.

"The Fed's actions to buy Treasurys is being hailed very positively," said Richard Sparks, senior equities analyst at Schaeffer's Investment Research. "We've had some upward momentum already over the last couple days," he added. "And the Fed's action adds fuel to that fire."

The rally continued from Tuesday's gains after the government issued a much stronger-than-expected report on February housing starts and building permits.

Tuesday's housing data, along with an upbeat report on retail sales last week, raised hopes that these critical areas of the economy are showing tentative sings of improvement.

At the same time, shares of Citigroup and other major financial institutions have been heading higher after top executives said last week that the banks were profitable in the first two months of the year. Citigroup (C, Fortune 500) rose 22% Wednesday while Bank of America (BAC, Fortune 500) gained 17%.

Bank shares also rose on continued speculation that government regulators will modify mark-to-market accounting rules, which could make it easier for financial institutions to sell illiquid assets weighing down their balance sheets.

While these factors helped lift stock prices in recent sessions, many analysts say the market still faces significant economic challenges.

"It's clearly a bear market rally," said Abigail Doolittle, a portfolio manager at Johnson Illington Advisors. "When the true economic reality sets in, we could be in for a pretty precipitous fall."

AIG: A House Financial Services subcommittee met Wednesday to discuss the government's $170 billion bailout of insurance giant American International Group (AIG, Fortune 500), especially $165 million in bonuses the company was giving out after receiving taxpayer-funded assistance.

Edward Liddy, AIG chief executive, told lawmakers that he found the bonuses "distasteful," but necessary because of legal obligations and competition. Still, he said he would ask employees who got $100,000 or more to give half back. (full story)

AIG has been the target of a public and political backlash over the bonuses. President Obama criticized the company Tuesday, and lawmakers are pursuing ways to block or tax the bonuses.

Liddy said Fed chairman Ben Bernanke had known about the bonuses for three months and that Treasury Secretary Tim Geithner found out about them two weeks ago - a week before Geithner has said he first heard of the bonuses from his staff.

The Treasury Department maintains that Geithner did not know about the bonuses until last week.

IBM: Dow component International Business Machines (IBM, Fortune 500) is in talks to buy Sun Microsystems Inc. (JAVA, Fortune 500) for at least $6.5 billion, according to The Wall Street Journal. The deal could create a new powerhouse in the computer server business to challenge the dominant player, Hewlett-Packard (HPQ, Fortune 500).

Sun, which makes the technology platform Java, surged 80% to $9.03 a share. Shares of IBM ended down 1%.

Economy: Before the market opened, the government announced an increase in consumer prices for February that was slightly higher than expected.

The Bureau of Labor Statistics said the Consumer Price Index rose a seasonally adjusted 0.4% in February. The core CPI, excluding volatile food and energy prices, rose 0.2%.

A consensus of economists surveyed by Briefing.com had forecast an overall increase of 0.3%, with core CPI up 0.1%. In January, CPI was up 0.3% and the core prices were 0.1% higher.

Separately, the Mortgage Bankers Association said mortgage applications surged last week, led by a 30% increase in refinancing activity. The spike comes as rates on home loans fall near historic lows, the MBA said.

Bonds: Treasurys surged, after the Fed's announcement, lowering the yield on the benchmark 10-year note to 2.51% from 3.01% Monday. Treasury prices and yields move in opposite directions.

Lending rates improved. The 3-month Libor rate fell to 1.29% from 1.3% Monday, while the overnight Libor rate was unchanged at 0.31%, according to Bloomberg.com. Libor is a bank-to-bank lending rate.

Other markets: In global trading, Asian markets advanced and European markets were mixed.

In currency trading, the dollar fell sharply against the euro and the pound.

U.S. light crude oil for April delivery fell $1.02 to settle at $48.14 a barrel. Earlier, the government reported that the nation's supplies of gasoline soared last week.

COMEX gold for April delivery fell $27.70 to settle at $889.10 an ounce. To top of page

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