Markets cheer easing of liquidity crisis, prudence of Fed with huge rally

S&P: +54.1 Dow: +420  Nas: +91.3

Markets rallied throughout the day, only pausing briefly immediately after the Fed’s ¾-point cut in both the fed funds rate and the discount rate, before surging into the close for gains of 4%. 

Better than expected earnings releases from LEH and GS in the premarket set the tone for the day, as investment banking firms enjoyed a huge relief rally following yesterday’s massive selloff.  The implications of the Fed’s extension of the discount window to cover investment bankers seemed to fully sink into traders.  Shares of LEH surged 46%, while GS gained 16%.  Major banks took part in the rally as well.  UYG, an ultralong financial ETF, gained 16% on the day.

Fed funds futures had priced in nearly a 100% chance of a full percentage point cut today.  Initial reaction to the 75 basis point move was a pullback in equities.  But the move gives the Fed more room to cut rates in the future and boosted the dollar. Once the move was digested, the markets declared their confidence in the Fed by closing at the highs of the session.

Dollar weakness has accompanied previous Fed cuts and has stoked inflation fears. The smaller than expected cut today gave the dollar a reason to bounce 5% against the euro and 3% against the yen. Gold lost $25 to $975, but oil ignored the stronger dollar and added $3 to $109.