Stocks Rally on Fed, FDIC News

The Fed said it would use all available tools to boost the economy. Reports that the FDIC would manage a "bad bank" to absorb toxic assets also lifted sentiment

U.S. stocks closed sharply higher Wednesday after the Federal Reserve announced that as expected, it was maintaining its 0% to 0.25% target range on the benchmark Fed funds rate. The central bank also reiterated that it will use "all available tools to promote the resumption of sustainable economic growth and to preserve price stability." Among them: the possible purchase of longer-term Treasuries.

The vow from the Fed followed reports that the Obama administration is nearing a deal to let banks remove soured assets from their books. And it preceded a House vote on President Obama's $825 billion economic stimulus plan.

Major indexes were able to log a fourth straight winning session Wednesday. The 30-stock Dow Jones industrial average finished higher by 200.72 points, or 2.46%, at 8,375.45. The broad S&P 500 index was 28.38 points, or 3.36%, higher at 874.09. And the tech-heavy Nasdaq composite rose 53.44 points, or 3.55%, to 1,558.34.

Treasuries fell in price, with the yield on the 10-year note rising to 2.65%. The bond market had been hoping for some direct Treasury purchases to be signaled, though the Fed's statement stopped shy of that for the moment, says Action Economics. The dollar index rose. Gold fell. Crude oil climbed.

In the Fed's statement released at the conclusion of its two-day policy meeting, policymakers said that the Fed "continues to expect that "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time."

The Fed said that information received since the the December FOMC meeting suggests that the economy has weakened further. The Fed said that as consumers and businesses have cut back spending, industrial production, housing starts, and employment have continued to decline steeply. It added that global demand appears to be slowing significantly.

"Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight," said the central bank. The Fed anticipates that a gradual recovery in economic activity will begin later this year, but "the downside risks to that outlook are significant."

"The focus of the Committee's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level," said the Fed. The central bank continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and said it stands ready to expand the quantity of such purchases and the duration of the purchase program "as conditions warrant."

The Fed also is prepared to purchase longer-term Treasury securities "if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets."

As for inflation, the Fed said that "in light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, it expects that inflation pressures will remain subdued in coming quarters." Policymakers see some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

Noted inflation hawk Jeffrey Lacker, president of the Richmond Fed, was the only FOMC member to vote against the move, preferred to expand the monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs.

"Clearly, the picture is for continued Fed intervention in markets other than the funds market to try to 'support the functioning of financial markets'," says Standard & Poor's chief economist David Wyss.