NEW YORK (Reuters) - Stocks shot higher on Wall Street and in Europe in a powerful rally on Friday after the Federal Reserve cut the discount rate it charges on direct loans to banks in a bid to calm anxious markets and defuse a global credit shortage.
The Fed’s surprising move came more than an hour before Wall Street’s opening bell, when it cut the discount rate by 50 basis points to 5.75 percent. The U.S. central bank cited slowed economic growth from deteriorating financial market conditions and tighter credit as the reasons for its action.
Afterward, the U.S. dollar fell against the euro and other major currencies as some dealers saw the Fed’s move as a step toward a benchmark interest rate cut.
“The discount rate cut today greatly increases the odds for a fed funds rate cut,” said John Canavan, a research analyst at Stone and McCarthy Research Associates in Princeton, New Jersey, adding that he expected a rate cut at the Fed’s next policy meeting on September 18.
The Fed left its target for the fed funds rate, or the overnight bank lending rate, unchanged on Friday at 5.25 percent.
Bond prices were mixed after the Fed’s discount rate cut decreased demand for safe-haven assets. But the two-year note US2YT=RR the maturity most sensitive to the outlook for interest rates, was up 3/32 in price, with its yield slipping to 4.19 percent in afternoon trade from 4.20 percent on Thursday.
The Dow Jones industrial average .DJI initially jumped 321.90 points to a session high at 13,167.68 on Friday morning in a relief rally fueled by the Fed's rate cut. The Standard & Poor's 500 index .SPX gained 39.06 points to an intraday high at 1,450.33 and the Nasdaq composite index .IXIC ratcheted up 73.89 points to an intraday high at 2,524.96.
By afternoon, stocks had trimmed gains, but were still sharply higher.
The Dow Jones industrial average .DJI was up 153 points, or 1.2 percent, at 12,998.44. The Standard & Poor's 500 Index .SPX was up 25 points, or 1.8 percent, at 1,436.60. The Nasdaq Composite Index .IXIC was up 37 points, or 1.5 percent, at 2,487.78. The Nasdaq had risen as much as 3 percent shortly after the open.
Global stock markets roared back to life on Friday after the Fed’s move, reversing some of their losses from Thursday’s wild day.
But Japan's benchmark Nikkei average .N225 didn't get the benefit of the Fed's decision, which came hours after Tokyo's Friday trading ended. The Nikkei sank more than 5 percent on Friday, its biggest one-day loss since the September 11 attacks in 2001. The yen's surge on Thursday hurt the shares of Japan's big exporters, including Toyota. The Nikkei plunged 874.81 points, or 5.4 percent, to end at 15,273.68, its lowest close since August 7, 2006.
Europe's FTSEurofirst 300 index .FTEU3 rose 2.3 percent, ending at 1,473.49, reversing its decline earlier in the session to a 2007 low of 1,426.51.
Britain's leading FTSE-100 index .FTSE had its biggest one-day percentage gain since early 2003, ending Friday's session up 3.5 percent at 6,064.2.
The policy-setting Federal Open Market Committee said it was monitoring conditions and was “prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.”
Equities markets have been battered by fears of financial instability, following troubles with risky U.S. mortgages and a squeeze on credit that had already prompted central banks, including the Fed, to pour billions of dollars of liquidity into the financial system.
Despite Friday’s recovery, investors and analysts continued to see a possibility that the Federal Reserve would have to intervene with further repurchases or rate cuts.
“I don’t think we’ve solved all the credit market problems with this move from the Fed today,” said Michael James, senior trader at regional investment bank Wedbush Morgan in Los Angeles. “There’s still just as much of a risk that the market could be down another 5 (percent) to 10 percent three months from now.”
In the U.S. Treasury bond market, the prices of short-dated debt rose, emboldened by the prospect of a potential federal funds rate cut, as stocks came off early session highs.
Only the 30-year bond US30YT=RR suffered, falling 15/32 in price, while its yield rose to 5.00 percent from 4.96 percent late on Thursday.
“When investors were borrowing yen-denominated deposits at low rates, a substantial share of those proceeds were directed toward Treasury bonds in order to get peak returns,” said William Sullivan, chief economist at JVB Financial Group.
But as the yen rose, there was “a reversal of the so-called yen carry trade with active liquidation of 20-year Treasury debt as a result,” he said.
The U.S. Dollar Index, which measures the dollar’s performance against a basket of major currencies, was down 0.5 percent at 81.322 from Thursday’s close at 81.729.
The euro rose to $1.3504, up 0.6 percent from $1.3423 late on Thursday.
But the dollar was slightly higher against the yen, rising to 114.35 yen in choppy trading from 114.24 late on Thursday. Earlier, the dollar had traded at 113.77 yen. The reversal in the yen’s direction against the dollar suggested there was some return in the appetite for risk.
U.S. crude oil futures for September CLU7 rose back above $72 a barrel on Friday after the Fed’s discount rate cut. On Thursday, oil prices fell on concerns that the credit crisis would slow the U.S. economy and curb oil demand.
Oil prices also got a lift on Friday after forecasts showed Hurricane Dean could be on course toward oil rigs in the Gulf of Mexico.
European gold XAU also got a boost from the Fed’s action and the declining dollar. COMEX gold for December delivery GCZ7 was at $666.80 an ounce, up $8.80, or 1.3 percent.
(Additional reporting by Kristina Cooke, Ellis Mnyandu, Kevin
Plumberg, Ellen Freilich, Gene Ramos and Frank Tang in New
York, Ana Nicolaci da Costa in London, Blaise Robinson in
Paris and Eriko Amaha in Tokyo)