Global Markets Rally After Fed Acts to Contain Credit Turmoil

In the world's financial markets, the subprime mortgage collapse may finally be contained.

When the U.S. Federal Reserve cut the discount rate at 8:15 a.m. New York time, futures on the Standard & Poor's 500 Index soared 3.6 percent in 46 seconds, erasing a 0.4 percent decline. By 8:30 a.m., Europe's Dow Jones Stoxx 600 Index was up 2.4 percent, reversing a 1 percent drop. Indexes showing the perception of U.S. corporate bond risk tumbled and three-month U.S. Treasury bill yields leapt as the safe haven of Treasuries faded.

Stock and corporate bond markets gained after the Fed showed it is willing to act to ease the credit crunch that began two months ago when defaults by subprime borrowers brought down two Bear Stearns Cos. hedge funds. While today's action may not be enough to end a slump in the corporate and mortgage debt markets, traders and investors started betting that more cuts will follow.

"The market had been clamoring for them to do something,'' said Pearse Conaty, a government debt trader at Bank of Ireland Global Markets in Dublin. "They had to step up to the plate and do something. The market is getting a little but it may want a lot more, like actual rate cuts.''

Citigroup Inc., the largest U.S. bank, and Lehman Brothers Holdings Inc., the biggest U.S. underwriter of mortgage-backed securities, led an advance in financial shares. Nokia Oyj and Deutsche Bank AG paced a rebound in Europe. Credit-default swaps of Countrywide Financial Corp., the largest U.S. mortgage lender, dropped, indicating the perceived risk of default is easing, and the company's stock had its biggest rise in seven years.

'Another Bullet'

A swoon that began in the subprime mortgage market, when borrowers with poor credit began defaulting on their home loans, spread globally in the past eight weeks, sapping demand for corporate bonds, stocks and commercial paper. The credit crunch caused losses at Australian hedge funds, German banks and Canadian short-term debt issuers.

"This is another bullet they were able to fire to delay, if not prevent, an actual easing,'' said Kenneth Hackel, managing director of fixed-income strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut. "But it's pretty clear this is a very serious event in the financial markets and if necessary they will ease.''

The FOMC reduced the rate at which it makes direct loans to banks by 0.5 percentage point to 5.75 percent, the first time it has cut borrowing costs between scheduled meetings since 2001. Policy makers left the overnight federal funds target rate unchanged at 5.25 percent.

In the statement, the committee said it is "prepared to act as needed to mitigate the adverse effects on the economy arising from disruptions in financial markets.''

'Very Worried'

"For the first time the Fed acknowledged the risk to the wider economy of all this recent market turmoil,'' said Thomas Kressin, senior vice president of Pimco Europe Ltd. in Munich. "Clearly the Fed got very worried as the crisis spread.''

U.S. two-year notes gained. The yield fell 8 basis points to 4.15 percent as of 10:53 a.m. in New York, according to bond broker Cantor Fitzgerald LP. The price of the 4 5/8 percent security due July 2009 rose 1/8, or $1.25 per $1,000 face amount, to 100 28/32. Ten-year yields were little changed at 4.67 percent. A basis point is 0.01 percentage point.

U.S. stocks rose the most in a week. The Standard & Poor's 500 Index gained 25.7, or 1.8 percent, to 1,436.93 at 12:36 p.m. in New York. The Dow Jones Industrial Average climbed 173.14, or 1.4 percent, to 13,018.92. The Nasdaq Composite Index rose 38.32, or 1.6 percent, to 2,489.39.

The S&P 500 has tumbled 9.1 percent through yesterday from a July 19 record amid concern defaults on subprime home loans will hurt bank earnings and spur an increase in borrowing costs as investors shun riskier debt. The Dow average was down 8.3 percent from its peak.

Citigroup, Lehman

Citigroup gained 80 cents to $48.35. Lehman increased $2.61 to $57.36. Both banks are based in New York. Espoo, Finland-based Nokia rose 4.4 percent to 21.95 euros. Frankfurt-based Deutsche Bank climbed 4.9 percent to 96.15 euros.

Europe's Dow Jones Stoxx 600 Index rallied 2.4 percent, the biggest gain since 2006, after falling as much as 1 percent earlier.

Credit-default swaps on the CDX North America Investment- Grade Index, a benchmark for the cost of protecting investment- grade bonds, dropped as much as 6 basis points to 72 basis points in New York after rising earlier today to 81 basis points, according to Deutsche Bank. In Europe, contracts on the iTraxx Crossover Series 7 Index of 50 companies, with mainly high-risk, high-yield credit ratings, fell 18 basis points to 338 basis points, Deutsche Bank prices show.

'High-Octane'

Wal-Mart Stores Inc., the world's largest retailer, announced plans to sell corporate bonds for the first time since April. The Bentonville, Arkansas-based company is offering debt with maturities of 10.5 years and 30 years.

"Suddenly the credit markets look like they have been drinking the high-octane fuel,'' CreditSights analysts led by Louise Purtle said today in a report.

Countrywide's stock and bonds soared and the perceived risk of default declined, measured by credit-default swaps. The Calabasas, California-based company's shares surged $3.96, or 21 percent, to $22.91. The biggest lender was upgraded to "neutral'' from "sell'' at Banc of America Securities LLC. Analysts including Robert Lacoursiere said the possibility of a "liquidity-induced distressed sale'' is unlikely.

Five-year credit swaps on Countrywide dropped 112.5 basis points to 437.5 basis points, according to CMA Datavision in London. That means it costs $437,500 a year to protect $10 million in bonds for five years.

Credit swaps on New York-based Bear Stearns, manager of two hedge funds that collapsed after bad bets on subprime mortgage securities, dropped 22.5 basis points to 160 basis points, CMA prices show.