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Stocks Surge after Historic Fed Rate Cut

The FOMC slashed the Fed funds rate 75 basis points and detailed other moves to stabilize markets and the economy

U.S. stocks jumped Tuesday after the Federal Reserve cut interest rates to almost zero and pledged to do even more to mend credit markets and revive the economy.

The Fed went deep, cutting the benchmark U.S. federal funds rate by three-quarters of a point, more than the half-point reduction that economists had expected. The new target range for the fed funds rate is 0% to 0.25%, the lowest level on record.

"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability," the Federal Open Market Committee (FOMC) said in a statement, adding it expects "exceptionally low levels for the federal funds rate for some time."

In further efforts to ease the credit crisis, the Fed committee also said it "stands ready" to expand purchases of debt and mortgage-backed securities, and may even buy longer-term Treasury securities.

Major U.S. equity indexes gained ground after the Fed's announcement.

On Tuesday, the 30-stock Dow Jones industrial average rose 359.61 points, or 4.2%, to 8,924.14. The broad S&P 500 index closed 44.61 points, or 5.14%, higher at 913.18. The tech-heavy Nasdaq composite index climbed 81.55 points, or 5.41%, to 1,589.89.

Stocks were up moderately even before the Fed announcement. According to S&P's Marketscope, the market was led higher by Goldman Sachs Group (GS). Despite announcing its first quarterly loss since going public, the Wall Street firm's results were better than feared, and its stock rallied 14%.

Also in Tuesday's session, traders weighed reports that showed U.S. housing starts plunging 18.9% in November, while the consumer price index fell 1.7%, and the core CPI, which excludes food and energy prices, was unchanged.

On the New York Stock Exchange, 27 stocks moved higher for every five in negative territory. On the Nasdaq, the ratio was 22 to 6 positive.

Bond prices jumped Tuesday after the Fed said it may buy long-term Treasuries.

The Fed's vote about its interest rate cut was unanimous. In its statement, the central bank said that since the its Oct. 29 meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. "Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further," the release said.

The Fed detailed the uncharted policy waters it's currently navigating in the following paragraph: "The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity."

Regarding inflation, policymakers said that "pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters."

The Fed's shift to a Fed funds rate "range" of 0%-0.25% is being seen by some as a larger than expected Fed easing, but this is exactly what had been priced in to the markets, according to Action Economics. "Fed rhetoric has been confusing since the Fed adopted a quantitative easing strategy in September and started paying interest on excess reserves ... The new mix of policy left an 'effective' Fed funds rate that should be expected to trade at a negative spread to the target, hence making the term 'target' a misnomer," says Action Economics. "The Fed fixed this problem with today's statement, as they will now reference the expected 0%-0.25% Fed funds rate directly, rather than indirectly with its outdated 'target' terminology."

John Ryding and Conrad DeQuadros of RDQ Economics said the Fed "went far beyond what we expected." After the Fed's aggressiveness, "Support for economic growth needs to come from fiscal policy at this point, and we expect passage of a massive stimulus package in the first quarter of 2009," they wrote, referring to the new Obama administration's proposals to stimulate the economy.

According to a Reuters report, the Bush Administration could act as early as Wednesday to approve a bailout of U.S. automakers from its bank rescue fund, with conditions likely to reflect at least those approved by the House of Representatives last week, key lawmakers and other sources said. A Treasury Dept. official said the agency and auto company executives continued to review financial and other information, and that no decision had been made. The White House is actively involved in the matter.

Treasury Secretary Henry Paulson said the government would have to be satisfied the industry could survive and compete in order to receive help. House Speaker Nancy Pelosi, a California Democrat, said the administration will likely use part of the $700 billion fund established in October to stabilize the financial services sector, rather than pushing the companies into bankruptcy, as some lawmakers have urged.

Democratic Sen. Carl Levin of Michigan, who helped spearhead a $14 billion rescue proposal that failed in the Senate last week, told reporters in Detroit that he expects help for both GM and Chrysler to come from the bank rescue fund and suggested GM could receive about $8 billion.

In economic news Tuesday, the U.S. consumer price index (CPI) fell 1.7% in November, while the core rate, which excludes food and energy prices, was flat, following respective declines of 1.0% and 0.1% in October. On a year-over-year basis, the headline pace slowed to 1.1% versus 3.7% previously. The core rate is running at a 2.0% year-over-year pace now, vs. 2.2% previously. Energy prices declined another 17.0% after an 8.6% drop in October, and are now down 13.3% year-over-year compared to an 11.5% pace of increase previously. Transportation costs fell 9.8%. Commodity prices were down 4.1%. Apparel prices edged up 0.3%. Food and beverage prices rose 0.2%. Medical costs rose 0.2%, as did education.

"The data are bond friendly, but may not have much further impact as a big headline decline was anticipated," says Action Economics.

U.S. housing starts plunged 18.9% to a 0.625 million unit annual pace in November, compared to a downwardly revised 0.771 million rate in October (from 0.791 million). Starts are down 47.0% year-over-year compared to a -38.0% clip initially reported for October. Permits fell 15.6%. Single family starts were down 16.9%, while multi-family starts dropped 23.3%.

The data were worse than expected, notes Action Economics.

In company news Tuesday, Goldman Sachs reported a $2.12 billion fourth-quarter net loss that translated into a $4.97 loss per share, above Reuters estimates of a $3.73 loss per share. Trading and principal investments registered net revenue declines of $4.36 billion, while compensation and benefits fell 46% from 2007 to $10.93 billion. Meanwhile, Goldman's Tier 1 capital ratio was reported at 15.6%.

Best Buy (BBY) posted better-than-expected third-quarter adjusted earnings per share of 35 cents, vs. 53 cents one year earlier, on a 5.3% same-store sales drop and a 16% total revenue rise. Wall Street was looking for 25 cents EPS in the current quarter. The company said the negative impact of the same-store sales drop and expense deleverage was partially offset by revenue gains from new store openings as well as an improvement in the gross profit rate. Best Buy maintains its guidance range for fiscal 2009 EPS of $2.30- $2.90, excluding an investment impairment charge.

American International Group (AIG) said its U.S. life insurance companies have sold to Maiden Lane II LLC (ML II), a newly formed Delaware limited liability company in which the Federal Reserve Bank of New York (FRBNY) is the sole member, their interests in a pool of $39.3 billion face amount of residential mortgage-backed securities (RMBS) held by their agent, AIG Securities Lending Corp., an AIG subsidiary, in connection with AIG's U.S. securities lending program. The agreement in principle between AIG and the New York Fed for this transaction was announced on Nov. 10.

Electricite de France SA is close to an agreement to buy half the nuclear power business of Constellation Energy Group (CEG) for $4.5 billion, trumping a takeover bid by Warren Buffett's MidAmerican Energy Co., people familiar with the situation said, according to a Bloomberg report.

Harley-Davidson (HOG) announced that President and CEO James L. Ziemer has informed the board of directors that he intends to retire in 2009. The board has formed a search committee to review both internal and external candidates. Ziemer will remain in his current role until a new CEO is in place.

General Electric (GE) confirmed fourth quarter EPS guidance of $0.50-$0.52, excluding previously announced $1.0-$1.4 billion of charges ($0.36-$0.42 Q4 EPS, including charges); it sees 2008 EPS of $1.78-$1.84 on $185 billion revenue. For 2009, it has set forth a framework of industrial businesses' earnings growth of 0%-5%. Also says it will no longer provide specific quarterly EPS guidance, but will provide a full-year operating framework with detail in the industrial and financial businesses.

In other U.S. markets Tuesday, the 2-year Treasury rose 05/32 to 101-04/32 for a yield of 0.65%; the 10-year Treasury jumped 2-08/32 to 113 for a yield of 2.27%; and the 30-year Treasury added 4-28/32 to 135.03/32 for a yield of 2.75%.

January West Texas Intermediate crude oil futures were down 35 cents to $44.16.

February gold futures were higher at $858.80 per ounce.

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