
Fed Slashes Rate by 75 Basis Points
Updated from 3:06 p.m. EDT
Stocks roared ahead on sudden hopes that Wall Street's bear market has hit bottom after the
Federal Reserve
cut its key interest rate target by 75 basis points, stopping short of the stock market's great expectations.
The central bank lowered the federal funds rate target to 2.25% from 3%. It also lowered the discount rate, the rate at which it lends to banks directly, by 75 basis points to 2.5%. It was the second cut to the discount rate in three days.
The market had been pricing in a full percentage-point cut in an environment jittery after the
swift and shocking demise
over the weekend of
Bear Stearns
( BSC), a major Wall Street investment bank.
"The Fed's decision today was anti-climactic after what happened over the weekend, and now there seems to be a bid out there for some of this mortgage-backed paper," says James Paulsen, chief investment officer with Wells Capital Management. "There's a sense developing that the Fed has finally gotten out in front of this crisis, and maybe we're at a bottom."
For its part, the central bank acknowledged that economic growth has weakened further recently amid a slowdown in consumer spending and the U.S. labor market, new language in its accompanying policy statement about inflation signaled that the Fed's continued willingness to keep pouring fresh liquidity into the financial system is approaching its limits.
"Inflation has been elevated, and some indicators of inflation expectations have risen," the statement said. "The committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully."
The announcement also contained evidence of growing divisions on the Federal Open Markets Committee, as two members -- Richard Fisher and Charles Plosser -- dissented from the majority, preferring less aggressive action at the meeting.
The market pulled back on the news briefly, but then mounted another strong rally. The
Dow Jones Industrial Average
closed up 3.5%, while the
S&P 500
and the
Nasdaq Composite
both added 4.2%.
"In the circumstances, it is hard not to welcome a 75 basis point easing but we think the signaling power of a 1% move would have been very powerful," said Ian Shepherdson, chief U.S. economist with High Frequency Economics. "Instead, we now know that the Fed is split, with at least two FOMC members still fretting about inflation."
The fed funds rate is now at its lowest level since 2004. Before Tuesday's announcement, the Fed had already slashed 225 basis points from its fed funds rate since the credit crisis began last fall -- with 125 basis points of the move coming in January alone.
The Fed's aggression is a sign of the magnitude of damage to the financial system and the U.S. economy that central bankers see as a potential in the continuing credit crisis. Meanwhile, critics have pointed to inflationary signs that are popping up in price statistics, commodities markets and currency markets as evidence that the Fed is over-stepping boundaries.
"There's no free lunch," said Barry Ritholtz, chief investment officer with Fusion IQ and contributor to
RealMoney.com
, in an interview on
CNBC
. "You can't give out all this free money and not expect bad repercussions."
The central bank has taken a number of other drastic measures to provide liquidity to the market. Over the weekend, the Fed came to the rescue of Bear Stearns, which was teetering on the brink of bankruptcy as markets refused to provide the bank with cash needed to meet margin calls and run its operations in return for illiquid derivatives and mortgage-backed securities of questionable value that were leveraged to the hilt.
Bear Stearns -- trading at close to $80 a share at the beginning of this month -- was acquired in a
for a stunning $2 a share by
JPMorgan Chase
(JPM) - Get Report
, with $30 billion in emergency funds provided by the Fed.
The bailout came as the Fed
slashed its so-called discount rate and let securities dealers borrow funds
directly from the Fed on similar terms as banks, marking the broadest expansion of the Fed's powers since the Great Depression. The move was the clearest sign yet that the Fed is scrambling to prevent a systemic breakdown in a financial system loaded bad debt.
Earlier this month, it offered to
lend as much as $200 billion in Treasury securities
to prime brokerages like
Goldman Sachs
(GS) - Get Report
and
Lehman Brothers
( LEH) in return for mortgage-backed securities that have been spurned by the market.
Inflation signs, however, continue to mount.
The Labor Department said its producer price index rose 0.3% in February, meeting expectations on Wall Street and marking a slowdown from January, but the core index, which excludes food and energy items, rose 0.5%-- its highest monthly increase since November 2006. The report showed wholesale price growth slowing last month due to falling food prices but price hikes in consumer products, automobiles and prescription drugs signaled a persistence of inflationary forces.
Meanwhile, crude oil and gold futures prices have soared recently to new record highs, while the value of the U.S. dollar has plummeted, prompting some investors to object to the Fed's willingness to increase the money supply. The dollar
vs. the euro and other currencies after the Fed's decision on Tuesday.
Fed Chairman Ben Bernanke has responded to criticism by noting that the central bank has a dual mandate to promote both price stability and economic growth, and currently, risks to economic growth outweigh the risks of inflation. On Monday, Treasury Secretary voiced support for the Fed's actions, saying they are necessary to prevent a catastrophe in the financial markets.
"Our priority is to provide stability for our financial markets," said Paulson.
Know What You Own:
Bear Stearns operates in the financial services industry, and some of the other stocks in its field include
Citigroup
(C) - Get Report
and
Bank of America
(BAC) - Get Report
. For more on the value of knowing what you own, visit TheStreet.com's
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