Markets respond to Fed; Dow up 233
The Federal Reserve finally answered Wall Street’s SOS.
Fed policymakers reacting to turmoil in the market cut their key discount rate a half percentage point Friday, hoping to stave off damage to the economy caused by weeks of heavy stock selling. The response by investors was swift — the Dow Jones industrials soared by as many as 320 points in a rally led by financial stocks, and finished up 233 points on the day.
Investors anxiously sought an interest rate cut to help alleviate the rapidly spreading effects of credit market problems that begin with the failure of billions of dollars in subprime mortgages. The central bank, while not caving to a broader rate cut, did send a definitive signal that it stands ready to act should the volatility on the Street persist.
“People were kind of baiting the Fed into doing something, and finally they did,” said Philip Dow, managing director of equity trading at RBC Dain Rauscher.
But questions remain. It’s unclear if the cut and the Fed’s injection of nearly $120 billion in liquidity into the banking system over the past two weeks will be enough to pacify investors’ worries about the subprime mortgage crisis spreading further and crippling the economy. Many economists think the Fed might further reduce the discount rate, which is the rate it charges to banks to borrow money, and may follow through with a cut in the federal funds rate, considered a more significant benchmark, at its Sept. 18 meeting.
The central bank made no mention of lowering its target for the fed funds rate, which has stood at 5.25 percent for more than a year. Many strategists believe Wall Street won’t settle down until the Fed lowers that rate.
But the discount rate cut was indeed a sign that the Fed recognizes the seriousness of the situation — in its statement, the central bank acknowledged that the turmoil in the financial markets was itself threatening the economy. The use of an intermediate step also gives the Fed more room to maneuver in the coming weeks.
“The mechanism of using the discount rate was in many ways a clever move by the Federal Reserve,” said Hugh Whelan, managing director at Hartford Investment Management Co.
If the market doesn’t get that cut, Friday’s gains may not stick, especially since it’s likely there will be plenty more news in the coming days and weeks of further troubles in the lending industry. Any mention of problems at subprime lenders or funds that invested in mortgages has sent stocks skidding over the past few weeks, and so have worries that tighter credit will stanch the flood of takeovers, which sent Wall Street to new highs earlier this year.
The Dow Jones industrial average surged 233.30, or 1.82 percent, to 13,079.08 Friday. Trading was still volatile throughout the day, but the blue chip index stayed in positive territory the whole time. The Dow is more than 6 percent below its record close of 14,000.41 reached July 19, and is down more than 1 percent for the week.
The Standard & Poor’s 500 index rose 34.67, or 2.46 percent, to 1,445.94, and the Nasdaq composite index rose 53.96, or 2.20 percent, to 2,505.03.
Bonds slipped as stocks rose, with the yield on the benchmark 10-year Treasury note rising to 4.67 percent from 4.66 percent late Thursday.
Traders who bet on how the Fed might alter rates expect the central bank will lower the benchmark fed funds rate at its next meeting on Sept. 18. Some investors are hoping for a cut in that benchmark rate even sooner.
“If the cut in the discount rate succeeds in restoring confidence, then perhaps there is no need for the Fed to cut rates at the Sept. 18 meeting,” said John Lonski, chief economist of Moody’s Investor Service.
He added, though, that the key line in the Fed’s statement Friday was its willingness to take more steps to prevent market volatility from harming the economy.
“That means the Fed is prepared to make a rate cut if stability doesn’t come,” Lonski said.