Stocks Rocket on the Fed's $200B Plan

The major indexes rise after the Federal Reserve announced plans to ease the credit crunch

by Ben Steverman

Wall Street cheered news that Federal Reserve will pour $200 billion into the troubled financial system. Stocks surged in the last half hour of trading, sending major indexes up 3.5% to 4%.

Working with the central banks in Europe, Canada and elsewhere, the Fed will offer loans to financial institutions and will accept as collateral various securities, including the mortgage-backed debt that has caused so much trouble since July.

Fed watchers like the move. "Dealers will be able to gain liquidity by swapping their mortgage-backed securities for Treasuries, the most liquid securities in the world," explained Tony Crescenzi at Miller Tabak in New York. He concluded: "Today's action reduces the chances at a 75 basis-point rate cut."

John Ryding, chief U.S. economist at Bear Stearns, agreed: "The Fed has creatively added another string to its bow as lender of last resort."

On Tuesday, the Dow Jones industrial average surged 416.66 points, or 3.55%, to 12,156.81 -- the largest point gain since July 24, 2002. The broader S&P 500 index rose 47.28 points, or 3.71%, to 1,320.65. The tech-heavy Nasdaq composite index jumped 86.42 points, or 3.98%, to 2,255.76.

Stocks have been falling in recent days amid worry about the credit markets, where JP Morgan analysts recently noted a "systemic credit crunch" has gotten worse over the past two weeks.

The Fed has used the so-called Term Securities Lending Facility, or TSLF, just as an overnight loan, but the new liquidity infusions will last 28 days. "The TSLF is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally," the Fed said in a statement.

Ryding at Bear Stearns said the action effectively fills "a gaping hole in the financing system" and reduces the pressure on the Fed to resolve economic problems solely through interest rate cuts. He also thinks that lowers the chances of a big three-quarters point cut to the Fed funds rate when the Fed meets on Mar. 18.

Action Economics, noting the reaction in credit markets, said it "looks like the Fed and other [central banks] are getting some bang for their buck on this one. Sources see it as a game changer at least in the short-run."

"Despite reports that the Fed was soon to announce new measures, the market was caught leaning the wrong way," said Marc Chandler of Brown Brothers Harriman. "In the bigger picture it is unclear whether this will prove sufficient, but it does demonstrate the Fed's resolve."

A key question going forward, says Action Economics, is whether "the Fed actions inspire the ratings agencies to uphold AAA ratings on the bond insurers and take a friendlier look at the financial sector in general, needed to turn the vicious cycle into a virtuous one."

Over in the commmodities markets, oil hit a record high overnight of $109.72 a barrel, but then retreated after the Fed announced its liquidity measure. But buyers stepped back in during the afternoon and by the close of trading, NYMEX April WTI crude futures settled up 83 cents at $108.73.

In economic news Tuesday, the U.S. trade deficit was $58.2 billion in January, lower than economists were expecting. The trade gap was 0.6% wider than December's $57.9 billion deficit, a number that was revised lower. Action Economics called the report "encouraging," showing imports and exports rising more than expected.

Among stocks in the news, Boeing (BA) said it will file a formal protest asking for a review of the U.S. Air Force's decision to award a contract for aerial refueling tanker to another contractor, a team of Northrop Grumman (NOC) and the European Aeronautic Defence and Space Company.

Google (GOOG) traded higher after reports that European anti-trust regulators gave the company unconditional approval to buy DoubleClick.

WellPoint (WLP) cut its first quarter earnings forecast from $1.44 per share to a new range of $1.16 to $1.26. It also reduced its full-year forecast, citing higher than expected medical costs, lower enrollment and the changing economic environment. A Goldman Sachs (GS) analyst reportedly downgraded the stock from buy to neutral.

Texas Instruments (TXN) cut its revenue forecast for the first quarter, from a range of $3.27 billion to $3.55 billion, down to a range of $3.21 billion to $3.35 billion. The range earnings expectations were also lowered by 3 to 4 cents per share.

Jones Soda (JSDA) posted a 39-cent loss in the fourth quarter, vs. 8 cents a year ago, as revenue fell 41%. The firm said its expansion plans have not been executed in a satisfactory manner.

European indexes rallied after the moves by the Fed and European central banks to boost liquidity and ease the credit crunch. In London, the FTSE 100 index was up 1.67% to 5,723.20. In Paris, the CAC 40 index added 1.39% to 4,630.27. Germany’s DAX index rose 1.98% at 6,575.99.

Asian indexes gained ground overnight. Japan’s Nikkei 225 index climbed 1.01% to 12,658.28. In Hong Kong, the Hang Seng index rose 1.28% to 23,995.35.

Treasury market

Treasuries dropped sharply due to the Federal Reserve's announcement of plans to increase liquidity through a $200 billion lending facility and increased swap lines with other central banks. The 10-year note sank 34/32 to 99-08/32 for a yield of 3.59%. The 30-year bond fell 32/32 to 97-18/32 for a yield of 4.52%.

The news was received as an assurance that the Fed will do what is necessary to stabilize the credit markets.

Steverman is a reporter for BusinessWeek's Investing channel.