Fed Cuts Discount Rate; Stocks Rebound

By Jason Simpkins

The U.S. Federal Reserve cut the discount rate to 5.75% Friday, and in a statement indicated that it is "prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets."

The Fed kept the benchmark Federal Funds rate at 5.25%. 

Discount window borrowing, which governs direct loans from the central banks to commercial banks, has been extended to allow renewable 30-day financing instead of a standard overnight loan.

In the statement, the Fed said the changes to the discount window's borrowing terms are "designed to provide depositories with greater assurance about the cost and availability of funding."

The Fed also pointed out that "market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward." This made the move, which drastically increases liquidity, necessary.

This marked the first reduction in borrowing costs between meetings since 2001. The decision demonstrates the central bank's willingness to put standard growth forecasts and inflation objectives aside to counteract the credit crunch (and an extremely volatile market).

However, it also reflects a deeper concern that restrictive lending conditions and market volatility will worsen the housing recession and thwart economic growth, which the Fed currently views as "moderate" - which is Fedspeak for "look out below!"

The rate cut gave a boost to the stock market, propping it up for at least a day. The Dow peaked early in the day, breaking 13,000 to climb as high as 13,166.46. It rose 233 points, or 1.82%, on the day to close at 13,079.08. The S&P 500 closed at 1,445.96, an increase of 2.46%, or 34.67 points. The Nasdaq closed even at 2,505.03.

European stocks had their highest jump in four years. The FTSE 100 closed up 205 points or 3.5%. The pan-European Dow Jones Stoxx 600 index climbed 360 points or 2.2%.  It was a different story for Asian stocks however, which closed before they got the positive news from overseas. Japanese stocks suffered their worst single day decline in seven years. The Nikkei 225 index plummeted 874.81 points, or 5.4%.

The Fed's action, as well as the onset of hurricane season, put some wind in the sales of oil bulls Friday, too. U.S. crude gained $1.31 to $72.31 a barrel after losing more than two dollars Thursday. London Brent crude was up 55 cents at $70.32.