CNN - Dow spikes 420 points on rate cut

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Dow spikes 420 points on rate cut

Stocks jumped Tuesday, with the Dow surging 420 points, its biggest one-day point gain in 5-1/2 years, after the Federal Reserve cut the fed funds rate by three-quarters of a percentage point, surprising investors looking for a larger cut.

According to early tallies, the Dow Jones industrial average rose 420 points, its fourth-biggest one-day point gain ever, or 3.5%. The broader Standard & Poor's 500 index climbed 4.2%, while the Nasdaq composite advanced around 4.2%.

"The market reaction was certainly positive after a little pullback," said Matt King, chief investment officer at Bell Investment Advisors. "It seems like they found the sweet spot with the decision today."

The central bank cut the fed funds rate, a key short-term lending rate that impacts consumer loans, by 75 basis points, to 2.25%, missing bets for a cut of 100 basis points. There are 100 basis points in one percentage point. (Full story).

Stocks had rallied ahead of the news as investors welcomed better-than-expected quarterly earnings from Lehman Brothers and Bear Stearns. But the market stumbled in the minutes after the 2:15 p.m. ET Fed announcement, before recharging in the last hour of trade.

The initial setback was likely a knee-jerk reaction because people looking for a bigger cut didn't get it, said Harry Clark, CEO at Clark Capital Management.

However, after digesting it, Wall Street was perhaps realizing that 75 basis points was the right decision, Clark said, in that it suggest both that the Fed remains on top of the problems in the economy, but is not so panicked as to need to cut rates by a full percentage point.

"I think a one-point move would have been too much, even if its what the Street thought it wanted," said Clark. "I think it was the right thing to do."

The Fed also cut the discount rate, which affects bank loans, by three-quarters of a percentage point, leaving it at 2.25%, after announcing an emergency quarter-point cut to that rate this weekend.

In the statement accompanying Tuesday's decision, Fed policy makers acknowledged the continued strain in the financial markets, the softer consumer spending environment and labor market, and also talked about higher inflationary pressure. (Read the statement here.)

The Fed has cut rates steadily since September as a means of shoring up the economy and combating a credit market crisis that has left Wall Street in its most precarious position in years.

The Fed has also injected billions into the economy. Most recently, the bank announced over the weekend that it has created another lending facility that allows big Wall Street firms access to short-term funding.

More moves along this line are what is needed said Clark, rather than additional rate cuts.

"All the rate cuts in the world won't solve the problem if no one wants to lend," Clark said.

Financial earnings impress. Lehman Brothers surged 38% after it reported lower quarterly sales and earnings that beat estimates, despite taking $1.8 billion in writedowns for bad mortgage bets.

Lehman also sought to reassure investors that it was not in danger of seeing a fate similar to that of Bear Stearns. The company said it has maintained a strong liquidity position. Lehman shares plunged Monday on worries about its solvency.

Goldman Sachs managed to report another quarter of better-than-expected sales and earnings, despite the ongoing market turmoil. Results, however, were sharply lower versus a year ago. Shares gained 13%.

Bear Stearns added 43% to trade at nearly $7 a share after tumbling 84% Monday on news that it had sold itself to JP Morgan Chase for $2 a share, marking a stunning collapse for the former No. 5 Wall Street brokerage. The stock traded at roughly $160 per share a year ago. Here's why the stock is trading so far above that $2 a share price.

Economic news. New home construction fell in February to an annual pace of just over a million properties, beating forecasts for a bigger drop. Building permits, a measure of builder confidence, tumbled more than expected.

The Producer Price Index (PPI), which measures inflation at the wholesale level, rose as expected in February. But core PPI, which excludes volatile food and energy prices, came in higher than expected.

Other markets. U.S. light crude oil for April delivery climbed $2.22 to $107.90 a barrel on the New York Mercantile Exchange. Prices hit a record $111.80 in electronic trading Monday.

COMEX gold for April delivery fell $1.50 to $1,001.10 an ounce. Gold hit an all-time trading high of $1,033.90 an ounce on Monday.

Treasury prices slumped, as investors cashed in after the previous session's big rally. The selloff raised the yield on the benchmark 10-year note to 3.46% from 3.30% late Monday. Bond prices and yields move in opposite directions.

In currency trading, the dollar fell against the euro but held above the all-time low it hit on Monday. The greenback also gained against the yen after touching a more than 12-year low Monday.