Fed's Nifty Fifty Fuels Wall Street

The unexpected 50-basis-point cut launches stocks.
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Updated from 2:44 p.m. EDT

The

Fed

slashed interest rates Tuesday, sending stocks sharply higher.

The central bank knocked 50 basis points off its closely watched fed funds target, citing increased economic uncertainty tied to the worldwide credit crunch. Economists were widely expecting a 25-basis-point cut.

"Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally," the policy-making Federal Open Market Committee said Tuesday afternoon in its statement. "Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time."

The

Dow Jones Industrial Average

soared 335.97 points, or 2.51%, to 13,739.39. The

S&P 500

jumped 43.13 points, or 2.92%, to 1519.78, and the

Nasdaq Composite

added 70 points, or 2.71%, to 2651.66.

Some observers said the Fed's decisive action suggests Fed Chairman Ben Bernanke is eager to preempt any damage to the economy while giving the central bank flexibility to fight future fires.

"This is one and done," said T.J. Marta, fixed income strategist at RBC Capital Markets. "They said there is no predominant policy concern going forward. So now depending on how the data plays out, they can do as they please."

Others sounded a more hopeful note.

"It was quite surprising to the Street, even though there was a small group that had hoped for a 50 basis-point cut," said Robert Pavlik, chief investment officer with Oaktree Asset Management. "It shows that the Fed is ahead of the curve. It helps to restore confidence and is likely to encourage business investment by lowering borrowing costs. This may even be recognized as the initiation point that housing finds a bottom."

Not everyone was jubilant, however.

"I'm a little disappointed," said Jim Bianco, president of Bianco Research. "I'm in the camp of creating another bubble is why we have the last one -- if they are going to go down that road I'm a little disappointed."

The Fed's shift to an easing posture comes amid considerable debate over how the central bank would handle a credit crunch that has hit financial stocks hard.

After months of maintaining that inflation was the main risk to the economy's health, the Fed said last month that "downside risks to growth have increased appreciably." This week, the Bank of England bailed out struggling mortgage lender Northern Rock after the bank failed to find funding in the wholesale lending markets.

Accordingly, the debate among market participants has recently shifted from whether the Fed would reduce rates to how deep the cut might be. Some argued in favor of a 50-basis-point cut, contending the economy's health is threatened by tightening credit conditions and losses tied to the housing and mortgage sectors.

Others suggested losses so far have been borne mostly by financial speculators and that by easing now, the Fed risks creating other problems in the economy. Skeptics of an extended easing campaign may be pointing to Tuesday's stronger-than-expected earnings from

Lehman

(LEH)

, which along with

Bear Stearns

(BSC)

has been seen as one of the Wall Street firms hit hardest by problems in the debt markets.

The news comes as Fed Chief Ben Bernanke confronts his first major policy decision, while his predecessor Alan Greenspan is out hawking a book about his reflections on nearly two decades at the helm of the central bank.

Bernanke's Fed has been loath to cut rates, because it seeks to remain vigilant against the threat of inflation. The inflation threat looms especially large because the dollar has been in decline against other major currencies. A declining dollar reduces consumers' purchasing power and feeds inflation by making imports more dear.

The Fed also cut its rate for emergency borrowing at the so-called discount window Tuesday by 50 basis points to 5.75%. The move comes just a month after the central bank surprised Wall Street by cutting half a point from the discount rate, as credit markets threatened to seize up.

Last month's discount rate cut came after Bear said two of its hedge funds had lost essentially all their value, and

Countrywide

(CFC)

had to get an infusion from

Bank of America

(BAC) - Get Report

to help fend off a severe liquidity squeeze.

Since then investors have struggled to make sense of a mixed picture. On Monday,

E*Trade

(ETFC) - Get Report

became the latest financial company to warn of a hefty hit from mortgages gone bad, but Tuesday morning

Best Buy

(BBY) - Get Report

posted solid numbers that suggest the consumer isn't yet in dire shape.

The fed funds rate had been at 5.25% since June 2006, when the central bank concluded a string of 17 consecutive quarter-point rate hikes.

Staff reporter Robert Holmes contributed to this article.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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