Stocks End Higher after Fed Cuts Rates

A strong GDP report helped lift equities Wednesday, though indexes see-sawed after the central bank announced a quarter-point easing

by Ben Steverman and David Bogoslaw

The Federal Reserve delivered a quarter-point cut in interest rates as expected on Wednesday, but wild swings in major stock indexes after the announcement showed that investors are struggling to understand whether the Fed's accompanying remarks suggest the central bank may be finished with pre-emptive moves to head off a slowdown in the U.S. economy.

Major U.S. stock indexes quickly reversed to the downside before rebounding to levels higher than before the Fed's announcement, as investors wrestled with whether or not the Fed can be counted on for further monetary easing in the near future. The initial negative reaction to the Fed's statement reveals the market's concerns that the knock-on effects of the housing slump and credit crunch haven't run their course. That would seem to reduce the significance of initial data showing U.S. gross domestic product grew faster than expected in the third quarter.

On Wednesday, the Dow Jones industrial average finished 137.54 points, or 1.00%, higher at 13,930.01. The broader S&P 500 index advanced 18.36 points, or 1.20% to 1,549.38. The tech-heavy Nasdaq composite index rose 42.41 points, or 1.51%, to 2,859.12.

On the New York Stock Exchange, 24 stocks traded higher for every nine that lost ground, while breadth on the Nasdaq was 20 to 11 positive. The big winners of the day were basic materials stocks such as Newmont Mining (NEM) and technology manufacturers, which stand to gain the most from a weaker dollar, given their exposure to export markets.

The Federal Reserve's policy committee cut the Fed funds rate by 25 basis points to 4.50% and also eased the discount rate by 25 basis points to 5.0%, to forestall further disruptions in the broader economy. But by saying that it now sees the inflation risk balancing the downside risk to economic and will be carefully monitoring inflation going forward, the Fed signaled it was not inclined to cut rates further until it sees data clearly showing that effects from the housing and financial sectors are spreading to the broader economy.

The key data points Ben Bernanke & Co. will be watching between now and the next policy committee meeting on Dec. 11: anything reflective of consumer spending, such as retail sales reports, and business spending, said Diane Dercher, chief economist at Waddell & Reed in Overland Park, Kans.

"Those will show us how tighter credit is influencing spending behavior, both on the consumer and business sides," she said.

Dercher said she expects consumer numbers to soften heading into next year, as people tighten their purse strings in response to higher energy prices, further deterioration in home equity and slowing income growth as unemployment starts to rise. A lot of mortgage rate resets lie ahead and high inventories in the housing market continue to weigh on home prices, she said.

"I don't think the Fed's out of the game yet in terms of not being there to lower rates," she said. "But they’re now wanting to see more evidence that there's an impact on the economy and data."

Advance GDP growth came in at 3.9%, ahead of economists' 3.1% forecast, and slightly better than the 3.8% growth seen in the second quarter. Consumption was up a "still robust" 3% while exports boomed, up 16.2%, Action Economics notes. Residential construction plummeted 20.1%. The initial GDP data suggest an economy that is growing faster than many expect, and that has less of a chance of being pushed into recession by housing's slowdown or the aftermath of the summer's financial crisis.

Back-to-back GDP gains of nearly 4.0% for the past two quarters show "the economy is incredibly resilient" in the face of the credit problems that rocked the markets in August, Edward Lazear, Chairman of the Council of Economic Advisors, said on CNBC. The impact of rising oil prices was mitigated by a strong labor market and, most importantly, by particularly strong growth in U.S. exports, which has been aided by expansion in the global economy, he said.

However, "while the economy statistically looks very good, it feels much worse than the numbers indicate,"