Traders on the floor of the New York Stock Exchange
Spencer Platt  /  Getty Images
Traders on the floor of the New York Stock Exchange watch the news of a bigger-than-expected rate cut from the Federal Reserve.
msnbc.com news services
updated 9/19/2007 9:47:47 AM ET 2007-09-19T13:47:47

An ecstatic Wall Street surged Tuesday, chalking up its best one-day rally in nearly five years, after the U.S. Federal Reserve delighted investors by cutting its benchmark interest rate by a larger-than-expected half a percentage point.

The Fed’s decision to cut the federal funds rate, which came shortly after 2:15 p.m. ET, was widely expected, but most on Wall Street were betting on a more modest quarter percentage-point cut in the key interest rate at the conclusion of the Fed’s policy meeting.

The Fed delivered a bigger rate cut, offering relief to investors worried that the housing and credit market turmoil seen over the summer could spread to the broader economy. It was the first cut in the federal funds rate in more than four years and analysts said it was a forceful move by the Fed against possible further weakening in the economy.

“I think the Fed was just trying to make a point, to create some liquidity and ease things for everybody from the consumer to the guy trying to sell his house,” said Warren Simpson, managing director at Stephens Capital Management in Little Rock, Ark.

The central bank’s decision and the wording of its accompanying economic assessment boosted a market that plunged during August amid fears that credit market problems, spawned by a continuum of mortgage defaults, would send the economy toward recession.

The Dow Jones industrial average closed Tuesday up 335.97 points, or 2.51 percent. The last time the index rose more than 300 points in one session was Oct. 14, 2002, when it gained 378 points.

The broader Standard & Poor’s 500-stock index surged 43.13 points, or 2.92 percent, while the Nasdaq composite index jumped 70 points, or 2.71 percent.

Video: Cramer: 'These guys get it!!!!!' Diversified financial companies, whose profits benefit from lower interest rates, which lower borrowing costs, were among the top gainers on Wall Street, along with industrial stocks, which are sensitive to the economy’s strength.

Shorter-term Treasury issues rose and longer-term bonds fell. The yield on the benchmark 10-year Treasury note finished little changed at 4.47 percent, the same as late Monday. Bond prices move opposite their yields.

In a statement accompanying its decision, the Fed said it was responding to the spreading impact of credit market problems on the rest of the economy, noting that “the tightening of credit conditions has the potential to intensify the housing [market] correction and to restrain economic growth more generally.”

There was no direct signal in the Fed’s statement that it would make further rate cuts. It said “some inflation risks remain” and that it will keep monitoring inflation developments. Still, it did not call inflation its “predominant policy concern” as it did after holding rates steady in early August.

Major Market Indices

“What [the Fed’s rate decision] says to me is you had a major shift in the last couple of months from a Fed that was very concerned about inflation to one that is concerned about the health of the financial markets, the availability of liquidity,” said Jerry Webman, chief economist at Oppenheimer Funds Inc.

The Fed cut the benchmark federal funds rate to 4.75 percent after keeping it unchanged for more than a year. It has not lowered rates since 2003.

Earlier, as investors awaited the central bank’s decision, they bid stock prices up sharply, pleased to see economic and corporate data come in better than expected.

Lehman Brothers Holdings Inc., the nation’s fourth-largest investment bank, posted a smaller-than-anticipated 3 percent decline in its third-quarter profits compared with a year ago. Lehman is the first of the major U.S. brokerages to report earnings from the most recent, tumultuous quarter. Other banks are due to report later in the week.

Lehman rose $5.87, or 10 percent, to $64.49.

The Labor Department’s August producer price index was also more favorable than the market predicted. Wholesale prices fell 1.4 percent last month, the biggest decline in 10 months and led by a 6.6 percent drop in energy costs. Core inflation, which eliminates often volatile food and energy prices, rose by a mild 0.2 percent, as expected.

“All of the cards have fallen nicely into alignment this morning,” said Phil Orlando, chief equity market strategist at Federated Investors, pointing to Lehman’s earnings, the benign PPI, and a calming third-quarter earnings outlook from Bank of America late Monday.

Investors seemed little-moved by the National Association of Home Builders report that its index of future home sales fell in September to a level equal to its all-time low, as expected. The index, which tracks how developers expect the housing picture will play out over the next six months, indicated weakness in the housing market could last into early next year.

In other positive earnings news, Best Buy Co. Inc., the country’s largest consumer electronics retailer, said its second-quarter profit rose 8.7 percent, more than analysts expected, thanks to strong revenues overseas and tighter controls on spending.

Best Buy rose $2.92, or 6.6 percent, to $47.46.

The price of crude oil surpassed $81 a barrel Tuesday on the New York Mercantile Exchange and closed up 94 cents at $81.51.

Though the effect of high oil prices on the U.S. consumer is a concern — especially given that the dollar is near record lows versus the euro — the Fed tends to measure inflation with food and energy prices stripped out.

In European trading, Britain’s FTSE 100 closed up 1.63 percent, Germany’s DAX index rose 1.27 percent and France’s CAC-40 rose 2.02 percent. In Asia, Japan’s Nikkei index fell 2.02 percent and Hong Kong’s Hang Seng Index fell 0.09 percent.

The Associated Press and Reuters contributed to this report.

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