January 22, 2008 / 9:07 AM / 10 years ago

U.S. rate cut soothes global stocks

<p>Trader Dirk Mueller reacts as he sits in front of the German DAX index board at Frankfurt's stock exchange January 22, 2008.Kai Pfaffenbach</p>

NEW YORK (Reuters) - The Federal Reserve's biggest interest rate cut in over two decades cushioned a plunge in global equity markets on Tuesday, but U.S. stocks still traded lower after Europe closed with solid gains.

The U.S. central bank sought to ease market worries after dramatic losses the day before and early Tuesday linked to fears of a spreading U.S. recession and tight credit.

The Fed slashed key interest rates by three quarters of a percentage point to 3.5 percent, marking the first such cut between regularly scheduled meetings since just after the September 11, 2001 attacks on the World Trade Center.

"It's the Fed coming to the realization the economy is moving lower, quicker, that the credit environment has not been fully flushed out," said Joseph Battipaglia, market strategist at Stifel Nicolaus. "It's not going to necessarily turn this market around."

In reaction to the Fed, bond prices jumped sharply, with two-year notes falling to their lowest in nearly four years, as investors prepared for still more rate-cutting. Bond prices rise as rates fall.

Investors remained skeptical whether the actions would be enough to prevent a worsening U.S. economic outlook and a steep retrenchment in corporate profits, even after U.S. equities recovered significantly from the day's worst losses.

The Dow Jones industrial average .DJI was down about 132 points or 1.13 percent, while the S&P 500 .SPX fell 17 points or 1.29 percent. But the market recovered from a much steeper early sell-off that took the Nasdaq down as much as 5 percent and shaved 450 points from the Dow.

European markets, meanwhile, recovered sharply after wide losses starting on Monday when U.S. markets were closed for the Martin Luther King holiday. The pan-European FTSEurofirst 300 index .FTEU3 ended 1.9 percent higher at 1,304.37 points, snapping a five-day losing run.

"There is hope that the rate cut will help stabilize banks' operational businesses," said Markus Steinbeis, head of European equities at Pioneer Investments.

Markets worldwide were gripped by waves of selling on Monday and early Tuesday which hit Asian equities particularly hard. Hong Kong's Hang Seng index lost $321 billion of its value in just the past two days.

"There's so much panic out there right now, I'm not sure it (the Fed rate cut) will help," Kim Rupert, managing director of global fixed-income at Action Economics in San Francisco as the downturn hit markets.

Traders expect the Fed to cut rates even further at its next scheduled policy meeting next week, a sentiment that fueled a big drop in the dollar against the euro. The prospect of much lower rates in the United States made European assets look even more attractive as European finance ministers during the day downplayed chances for a similar rate-cutting action by the European central bank.

"Current events remain solidly dollar-negative," said Alan Ruskin, chief international strategist at RBS Greenwich.

"Plainly, the Fed realized that to try stay ahead of the market they had to act immediately. It smacks of panic."

Emerging market stocks also recovered from the extreme selling of the prior session. Brazil's Bovespa surged over 4 percent as lower benchmark U.S. rates boosted the appeal of developing countries' higher-yielding securities.

In energy markets, oil cut some of its losses to trade around $89 a barrel on Tuesday after the Fed's action, which traders hoped would bolster flagging demand. U.S. crude was trading at $89.64, down 72 cents.

Reporting by Pedro Nicolaci da Costa. Editing by Richard Satran

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