Fed Move Lifts Stocks

Bernanke & Co. have answered the market's pleas—sort of—with a cut to the discount rate. Stocks soared on the news

by Ben Steverman and Karyn McCormack

Investors finally had something to cheer about Friday. The Federal Reserve swooped in Friday morning and made an unusual move of cutting the discount rate to ease credit worries at troubled financial institutions. However, the Fed kept its key federal funds rate at 5.25% -- leaving many experts to wonder when it will lower that borrowing rate.

The discount rate -- the interest rate that the Fed charges to make direct loans to banks, was lowered from 6.25% to 5.75%. The move was made "to promote the restoration of orderly conditions in financial markets," the Fed said in a statement.

The Fed also hinted it was willing to step in again if conditions deteriorated further. "Tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward," the statement said. Policymakers are "monitoring the situation and [are] prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets."

Though it's still a mystery how bad the credit crunch will get and when the Fed will really act, investors thought the effort was enough reason to buy stocks after a few days of heavy losses.

On Friday, the Dow Jones industrial average jumped 233.30 points, or 1.82%, to 13,079.08 -- after shooting up nearly 322 points in the first few minutes of trading.

The broader S&P 500 index rose 34.67 points, or 2.46%, to 1,445.94. The tech-heavy nasdaq composite index rose 53.96 points, or 2.2%, to 2,505.03.

The CBoE's volatility, or VIX, equity index -- a measure of market fear -- fell sharply Friday and was around 29.96, well below Thursday's peak of 37.50 when stocks were tumbling.

One report showed that the market turmoil has taken a toll on consumers. The University of Michigan consumer sentiment index fell in August, to 83.3 from 90.4 in July, as the boost from falling gasoline prices and a tight labor market wasn't enough to offset problems in the financial markets. The report was much weaker than expected.

Next week's economic calendar is very light, with the key reports on durable goods orders and new home sales coming at the end of the week.

Thursday set the stage for the return of buyers attracted by low prices after days of carnage. On Thursday, the Dow average, the S&P 500 index, and Nasdaq clawed their way back after being down 11% to 12% from their July 19 highs. Market pundits were debating about whether the Fed needs to cut interest rates, and if its injections of cash to the market through repos were enough to ease the credit crunch.

Friday's discount rate cut by the Fed should help provide some much needed liquidity to institutions who are suffering from having a lot of dicey paper on their books, says Action Economics, noting that the cut in this rate is symbolic to some extent. Along with Treasuries and top tier debt, the discount window will accept mortgage backed securities, commercial paper, construction loans, consumer loans, and much of the "alphabet soup" paper that has seized up, explains Action Economics.

"The story now is will institutions use the facility and just how much liquidity the window will end up providing," wonders Action Economics.

Bill Tedford of Stephens Capital Management says he was "a little underwhelmed" by the Fed move, which by itself probably won’t solve the market's problems. The cut is largely symbolic, he explains, because "very few institutions take advantage of the discount window anyway."

However, David Wyss, chief economist at Standard & Poor's thinks the move was more than symbolic and has "real meat." He notes that the opening of the lending window for 30 days, rather than the usual one week limit, was key, and shows that the Fed won't judge banks in this time of emergency. "The Fed has performed monetary surgery with a scalpel rather than a sledge hammer, as it addresses the short-term paper market, not the overall cost of borrowing," he said in a note.

Noting that the Fed doesn’t like to shock the markets, Tedford thinks Bernanke & Co. is gearing up for a rate cut. Many economists agree that the Fed will lower the federal funds rate, perhaps as early as September. Goldman Sachs predicted that the Fed will cut rates three times before yearend.

The Fed's decision was welcome news to beaten down financial stocks like Bear Stearns (BSC) and mortgage lenders such as Countrywide Financial (CFC), which rebounded on Friday.

Among other stocks in the news, Hewlett-Packard (HPQ) reported earnings of 66 cents per share, vs. 48 cents a year ago on a 16% rise in revenue. The stock was up more than 3% in pre-market trading.

Dell Inc. (DELL) says that as a result of an independent investigation that identified errors and irregularities in its accounting, it will restate its fiscal year financial reports from 2003 to 2006, along with the first quarter of 2007.