The Federal Reserve electrified financial markets Thursday with a fresh cut in interest rates just two weeks after its previous move.
In a rare action between meetings of its monetary policy committee, the Fed sliced the overnight federal funds rate by a quarter-point, to 5%. And it reduced its own discount rate to 4.75%, also by a quarter point.
News of the Fed's decision hit Wall Street's trading desks at 3:15 p.m. Bank stocks led the market's jubilation, with the Standard & Poor's bank index soaring 5.7% in value, while the Dow Jones industrial average rose 4.2%.
Lower rates are seen as benefiting banks because they relieve debt servicing pressure on borrowers and stabilize credit quality.
The Dow, which was ahead 105 points just before the Fed's announcement, doubled its gain in three minutes. It closed the day up 330.58 points, to 8299.36, moving back past the 8200 mark for the first time since Aug. 26.
The yield on the Treasury's benchmark 30-year "long bond," which had been hovering just above 5% after a traumatic week of trading, immediately dropped to 4.96%. The yield on the 10-year treasury, a key for mortgage rates, fell to 4.41% from 4.57%.
The Fed's move surprised almost everyone. Most economists applauded the move while a few said domestic economic conditions did not appear to warrant such a cut.
"This demonstrates that we have a pragmatic Fed, ready to go with the facts and not get hung up on theories," said Nicholas S. Perna, chief economist at Fleet Financial Group, Boston. "I imagine one of their big concerns was to counter the self-tightening of the credit markets we have been seeing lately."
But Robert A. Brusca, chief economist at Nikko Securities, maintained: "The U.S. economy is at full employment. If you look at Japan or Europe, where they have some slack, they're the ones who should be cutting.
"The Fed is concerned about the financial markets, and that has dominating their thinking." he said, adding that "this seems to have had the intended effect."
Indeed it did. Shares of BankAmerica Corp., for example, were trading off 93.75 cents before the Fed's announcement because of the company's unexpectedly low earnings announced the day before. After the Fed moved, investors shoved their worries aside and bid the stock up $3 in five minutes. BankAmerica closed for up the day $1.1875, to $49.25.
Wall Street had been pining for additional cuts in interest rates after the Fed reduced the federal funds rate to 5.25% on Sept. 30. On Oct. 8 the market suddenly rallied in the last half hour of trading on rumors that the Fed was meeting to cut rates.
In its official statement, the Fed said its decision Thursday was dictated by requests from the Federal Reserve banks in nine cities.
"Growing caution by lenders and unsettled conditions in financial markets more generally are likely to be restraining aggregate demand in the future," the Fed said in a statement. "Against this backdrop, further easing of the stance of monetary policy was judged to be warranted to sustain economic growth in the context of contained inflation."
While investors rushed into the market after the Fed cut rates, some economists said the secondary reaction could be different.
"The Fed's decision to act before its next meeting (Nov. 17) suggests the situation is worse than the stock market thought," said Sung Won Sohn, chief economist, Norwest Corp., Minneapolis. "Once the market settles down, this could sink in."