Stocks Soar on Fed's 75-Point Rate Cut

Equities surged Tuesday after the central bank provided another boost to liquidity, citing concerns over growth and heightened inflation risks

The markets didn't receive exactly what they expected from the Federal Reserve on Tuesday, but investors seemed to be quite pleased with what they got.

While investors were widely looking for the Federal Reserve to cut the benchmark Federal funds target rate by a full percentage point to 2.00%, the Fed shorted Wall Street by a quarter. The policy-setting Federal Open Market Committee voted 8-2 to cut the rate by 75 basis points to 2.25%, and also effected a similar-sized cut in the discount rate, to 2.5%.

Before the Fed's announcement, major indexes were enjoying a nice rally. In the immediate aftermath of the decision, major averages gave back a small portion of their earlier gains, but they came back with force in the final hour of trading.

Investors also took some cheer Tuesday from some better than expected earnings from two big Wall Street firms.

The Dow Jones Industrial Average, after a brief 87-point dip, surged to end 420.41 points, or 3.51%, higher at 12,392.66. The S&P 500 index, which also gave back some of its early upside move, closed up 54.14 points, or 4.24%, at 1,330.74. The Nasdaq composite index did not change much in the wake of the rate cut but it too charged higher toward the end of the session, finishing 91.25 points, or 4.19%, higher at 2,268.26.

On the New York Stock Exchange, 29 stocks traded higher for every 3 that lost ground, and on the Nasdaq the ratio was 22-9 positive.

In its post-meeting statement, the policy-setting Federal Open Market Committee said that recent information indicates that the outlook for economic activity has weakened further. The Fed also noted that growth in consumer spending has slowed and labor markets have softened.

"Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters," said the FOMC.

But inflation concerns remain. "Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization."

"Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully."

The Fed said that its recent rate cuts and its measures to foster market liquidity should help to promote moderate growth over time and to mitigate the risks to economic activity.

"However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability."

The FOMC left the door open for more easing ahead, says Action Economics.

The vote was 8-2 with two dissents, Dallas Fed president Richard Fisher and Philadelphia Fed president Charles Plosser, both against the size of the cut, preferring a less aggressive action.

While the 75-point easing was disappointing in one sense, "the Fed did so much over the weekend and on Monday by opening up the discount window to broker-dealers, and with Goldman Sachs and Lehman Brothers earnings [beating estimates on Tuesday], they probably decided it was unnecessary to push it and that 75 would be enough," says Bill Stone, chief investment strategist at PNC Wealth Management in Philadelphia. "And the markets are storming back."

The U.S. central bank also left the door wide open for more easing in the future if needed, he adds.

Arun Raha, U.S. senior economist at Swiss Re, interprets the Fed's rate cut differently. In a statement, he wrote that the Fed's willingness to ease rates as much as 75 basis points "shows it doesn't believe that the action it took last week to expand its securities lending program, or its emergency measures over the weekend to increase market liquidity, are enough."