Wall Street ended another tumultuous session with a sizable gain today, partly recovering from its worst sell-off in years after the Federal Reserve said it was keeping interest rates steady. The US central bank soothed fears of a worsening financial crisis even as the market waited to learn the fate of troubled insurer American International Group Inc.
In a statement accompanying its decision, the Fed noted the growing strains in the financial markets a day after the Dow Jones industrials plunged 504 points in reaction to continuing turmoil in the financial sector. The Fed also noted the ongoing weakening of the labour market. But it also sought to give some reassurance by saying it expected its policy moves to foster moderate economic growth over time.
The Fed has cut its target federal funds rate by 3.25 percentage points to its current level of 2 per cent over the past year. Many on Wall Street expected the Fed to keep rates steady but there was some hope that the central bank would try to calm uneasy financial markets with a rate cut.
The fact that the Fed didn't lower rates was a sign that it doesn't believe the economy needs that type of stimulus. It reiterated that it believed its moves to inject more liquidity into the banking system to help struggling financial institutions would help them, and in turn the economy overall.
According to preliminary calculations, the Dow rose 141.51, or 1.30 per cent, to 11,059.02, after falling about 100 points immediately after the Fed announcement. The Dow at turns rose and fell as much as 175 points in fractious trading; yesterday, it suffered its largest drop since the September 2001 terror attacks.
Broader stock indicators advanced. The Standard & Poor's 500 index rose 20.90, or 1.75 per cent, to 1,213.60, and the Nasdaq composite index rose 27.99, or 1.28 per cent, to 2,207.90.
Yesterday, the Dow fell 4.4 per cent, the S&P gave up 4.7 per cent and the Nasdaq fell 3.6 per cent.
Bond prices fell sharply today as investors turned away from the safety of government debt. The yield on the benchmark 10-year Treasury note, which moves opposite its price, rose to 3.52 per cent from 3.41 per cent late yesterday.
The Federal Reserve has decided to hold US interest rates at 2 per cent despite speculation that it would announce a cut to boost confidence in battered financial markets.
Policy-makers have rates on hold in the hope that already low rates and expanded central bank lending will stabilise the economy.
On Sunday, the Fed said it would accept a wider range of collateral, including equities, from investment banks seeking central bank loans in an effort to help keep markets functioning.
The tumble in stocks followed a whirlwind weekend that brought the bankruptcy of 158-year-old Lehman Brothers Holdings, the sale of investment bank Merrill Lynch to Bank of America, and a scramble for more cash by insurer American International Group.
Today the storm showed little sign of letup, as investment bank Goldman Sachs said quarterly profits slid 70 per cent and shares in Britain's HBOS plunged by about a third.
However, US stocks rose this evening after CNBC television reported that US government money had now been put on the table in discussions over a financial lifeline for embattled insurer American International Group (AIG).
Stocks had slid earlier as investors feared that without a financial lifeline, AIG's survival might come into question as the credit squeeze weighs on the company.
The MSCI main world equity index fell 1.7 per cent, its lowest since December 2005. Markets fully expect a quarter-point Fed interest rate cut today as indicated by short-term rate futures.
Some believed that if the Fed's rate-setting Federal Open Market Committee decided to lower borrowing costs, it would do so decisively to send a convincing message to markets.
"If the FOMC does opt for a rate cut, 50 basis points is much more likely than 25 basis points, which would be seen as a token gesture in the current climate," economists at Goldman Sachs wrote, adding they believe a no change in rates is the most likely outcome.
Policy-makers said at their previous rate-setting meeting August 5th that the Fed would act as needed if economic and financial developments posed a threat to sustainable economic development or stable prices.
The most recent financial turmoil is the latest in a series of shocks that began with the collapse in US housing markets and a surge in US mortgage delinquencies, many of them subprime loans made to borrowers with little ability to meet the terms of their loans.
The Treasury Department September 7th announced the government would take over operations of mortgage finance enterprises Fannie Mae and Freddie Mac, and was ready to infuse both institutions with up to $200 billion in capital if necessary to keep mortgage markets operating smoothly.
While US government officials made clear in recent days they would not use public funds to help Lehman avert bankruptcy, as they had done in March with investment bank Bear Stearns or with the mortgage enterprises, the Fed expanded its borrowing facilities to accept equities as collateral.
Since the credit crisis exploded a little more than a year ago, Fed officials have distinguished between special lending facilities established to ensure that money flows without interruption and interest rate reductions aimed at spurring economic activity.
Yet the severity of recent problems has led many to call for the Fed to go back to the most powerful weapon in its arsenal, rate cuts.
Even so, many observers believe the Fed, which worried in August that inflation was high and that indicators of inflation expectations were elevated, will hold fire on borrowing cost reductions today.
In making any shift that would open the door to rate cuts, the Fed could cite a weakening economy and a more benign outlook for inflation. The labor market picture remains steadily dismal, with eight consecutive months of job losses and the highest unemployment rate in five years in August.
In the meantime, although inflation hit a 17-year peak in July, as measured by the year-over-year rise in the Consumer Price Index, crude oil prices have declined by 34 per cent since highs in early July as global demand has slowed, offering some hope that prices will moderate.
AP