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Fed Announcement Helps U.S. Stocks Rebound

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Stocks surged Tuesday as Federal Reserve policymakers announced that they would keep the target range for the federal funds rate at 0% to 0.25%, and that they planned to keep rates in a very low range for the next two years.

“The Committee currently anticipates that economic conditions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013,” the Federal Open Market Committee (FOMC) said in its announcement.

Immediately after the FOMC announcement at 2:15 p.m., the Dow Jones industrial average dropped to a low of 10,600 but recovered in late-afternoon trading to close at 11,239, up 429.92 points, or 3.98% higher. The Dow on Monday fell 634 points, or 5.6%. The S&P 500 surged 4.74% and the Nasdaq jumped 5.29%, erasing most of both indexes losses from Monday.

Seven of the 10 FOMC members, including Fed Chairman Ben Bernanke, voted in favor of the announcement. However, three members—Richard Fisher, Narayana Kocherlakota and Charles Plosser—voted against the action, saying they would have preferred using the same language used in the prior FOMC announcement on June 22. The prior statement didn’t name a specific period or year for maintaining rate policy at its current historic low.

The June 22 announcement said that the FOMC continues to anticipate that economic conditions “are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

At the end of June, the Fed completed its second round of quantitative easing with the purchase of $600 billion of longer-term Treasury securities. On Tuesday, the Fed said it would maintain its existing policy of reinvesting principal payments from its securities holdings. It made no mention of a third round, known as QE3.

The Fed’s announcement came a day after the U.S. stock market plummeted on economic fears following the late Friday downgrade of U.S. debt by Standard & Poor’s. But the announcement, released as regularly scheduled six weeks after the prior one, was unrelated to the S&P rating action and in fact made no mention of the downgrade. Instead, it referred to earlier negative events such as the earthquake in Japan last spring and a deterioration in overall U.S. labor market conditions in recent months.

Analysts said the Fed’s economic assessment in its Tuesday policy statement was more downbeat than earlier this year.

“The policy statement accompanying today’s no-change monetary decision included a second and deeper downgrade in the Fed’s perception of economic conditions,” wrote Guy LeBas, chief fixed-income strategist for Janney Capital Markets, in a comment on Tuesday. “Gone was the reference to ‘somewhat more slowly’ evolving growth conditions, a phrase which was replaced by “considerably slower’ growth. The statement also made reference to an outright ‘deterioration in labor market conditions,’ a factor the Fed previously cited as a reason it might move towards more accommodative policy.”