MarketView for March 18

Summary 

Stock prices were mostly higher on Wednesday after the Federal Reserve surprised Wall Street when it said it will buy long-term Treasury bonds for the first time in four decades in an effort to revive the recession-hit economy. The rally in stocks was another step forward in the bounce off of 12-year lows reached earlier this month.

The Fed's move, aimed at resuscitating lending, drove the yield on the 10-year U.S. Treasury note to its biggest one-day drop since the 1987 stock market crash and 30-year mortgage rates fell to around their lowest levels on record. Wall Street appeared willing to bet that the Fed's move would kick-start lending. Bank of America saw its share price jump 22.3 percent to $7.67.

The Fed said it will buy up to $300 billion worth of longer-term U.S. government debt over the next six months and expand purchases of mortgage-related debt to help ease credit market conditions in its latest action to lower borrowing costs. While an easing of credit market strains will likely help business and consumer spending, the announcement also raised concerns over inflation, sending gold prices up more than 3 percent.

The Nasdaq was driven higher by possible deal activity after the Wall Street Journal reported that IBM was likely to pay $10 to $11 per share to buy Sun Microsystems. The price implies a premium of more than 100 percent from Sun Micro's closing price on Tuesday. Shares of Sun rose nearly 79 percent to $8.89, while IBM's shares were down 1 percent to $91.95.

More good news for the tech sector came after the closing bell when Oracle reported stronger-than-expected quarterly results and said it would pay its first dividend to shareholders. Oracle's stock rose 5.9 percent to $16.77 in extended-hours trading.

Fed Plans to Buy Government Debt

The Federal Reserve on Wednesday said it planned to add an additional $1 trillion into the economy in an aggressive bid to battle a deep recession, in part by purchasing government bonds for the first time since the 1960s. Concluding a two-day policy meeting, the central bank said it would buy up to $300 billion in longer-term Treasuries to bring down borrowing costs, harkening back to a program called "Operation Twist" that ran from 1961 to 1965. The decision caught Wall Street off guard.

While the Fed had said it was considering such a move, it had downplayed it in recent weeks. As recently as March 6, New York Federal Reserve Bank President William Dudley had said buying longer-term government debt was not the most efficient way to ease credit market strains.

The price of U.S. government bonds moved sharply higher after the announcement, with yields taking their biggest one-day tumble since 1987. Stock prices were higher, while the dollar fell sharply.

In addition to purchasing Treasury debt, the Fed said it would expand an existing program to buy debt and securities issued by mortgage finance agencies by $850 billion to $1.45 trillion, an effort to lower mortgage rates.

The Bank of England's recent success in driving interest rates down by buying government debt may have been a factor in the U.S. central bank's decision. By driving down yields on benchmark debt, the Fed hopes to lower a wide array of credit costs for consumers and businesses.

The New York Fed said it would begin buying the Treasury debt late next week and planned to focus on securities with maturities ranging from two years to ten years. It said it would make purchases about two to three times a week.

In addition to ramping up its efforts to pump money into the recession-struck economy, the Fed unanimously decided to hold its target for overnight interest rates in a zero to 0.25 percent range -- the level reached in December. One Fed official, Richmond Federal Reserve Bank President Jeffrey Lacker, returned to the fold after dissenting in January.

The Fed said rates would stay low for "an extended period," a more explicit vow to stay on hold with rates for a prolonged time than it had offered in recent months. Having pushed overnight rates virtually to zero, the Fed has turned its focus to flooding stressed credit markets with cash in the hope of restarting lending and restoring growth -- a policy Fed chief Ben Bernanke has dubbed "credit easing."

Bernanke said on Sunday that repairing the tattered financial system was necessary to secure a recovery for the economy, which has been stuck in recession for more than a year. The Fed on Wednesday pointed to worsening prospects for the economy, dropping any specific reference to the likelihood of the recession ending this year. The central bank instead said only that the near-term outlook is "weak" and that stimulus measures should lead to a gradual resumption of growth.

This week, the Fed began taking bids under another marquee program designed to spur student, auto, credit card and small business lending. This program will initially aim to inject $200 billion into the economy, but the Fed has said it could be ramped up to $1 trillion.

While the Fed has gone to extraordinary lengths to try to get credit flowing, the economy is still in a nose dive. Gross domestic product shrank at a 6.2 percent annual rate in the fourth quarter, the deepest contraction since early 1982, and a decline of 5 percent or more this quarter is quite possible. The unemployment rate, which has already hit a 25-year high of 8.1 percent, is expected to climb through the year.

Inflation Moves Higher

Inflation rose in February on higher gasoline and apparel prices, government data showed on Wednesday, indicating some pricing power in the recession-hit economy and easing fears of deflation for now. In another snapshot of the economy, the country's current account deficit for the fourth quarter contracted sharply as imports fell more rapidly than exports.

However, it was the Labor Department's Consumer Price Index that attracted the most attention. In February, the overall CPI rose 0.4 percent, the biggest monthly gain since last July, and above January's gain of 0.3 percent.

About two-thirds of the rise in February's inflation rate came from the 8.3 percent jump in gasoline prices. Compared with a year ago, consumer prices rose 0.2 percent after being flat in January. Core CPI, which excludes volatile food and energy prices, gained 0.2 percent in February, after rising at the same rate the prior month.

The February CPI data showed apparel prices up 1.3 percent, the biggest rise since a 1.5 percent gain in March 1990. Also contributing to the increase in the core inflation rate were new vehicle prices, up 0.8 percent, the largest advance since November 2004. Compared with a year ago, core CPI rose 1.8 percent, creeping up from 1.7 percent in January, but still below the Fed's comfort zone of 2 percent.

There is an argument that the Fed's liquidity injections are expanding the money supply base and may ignite inflation going forward if the central bank does not deploy adequate measures to withdraw that money from the system once the economy recovers.

The anemic U.S. economy is causing a slump in domestic demand, which is crimping the appetite for imports. Data from the Commerce Department showed the U.S. current account deficit for the fourth quarter contracted sharply to $132.8 billion, the smallest since 2003's final quarter, from $181.3 billion in the third quarter of 2008.

The current account, which covers goods, services and income transfers, is the broadest measure of total U.S. trade with the rest of the world. The fourth-quarter current account deficit equaled 3.7 percent of gross domestic product, down from 5.0 percent in the third quarter, and the lowest since 3.4 percent in 2001's fourth quarter.

Crude Falls

Futures for sweet domestic crude for April delivery rose to nearly $50 in post-settlement trading late Wednesday, rising as the value of the dollar fell. U.S. oil has not reached $50 per barrel since January 6. April delivery crude hit a high of $49.83 a barrel, after settling earlier on Wednesday at $48.14 a barrel.

Crude oil prices often rise when the value of the dollar falls because buyers using other currencies like the euro have increased buying power. Oil prices fell earlier on Wednesday after weekly government data showed crude inventories at their highest level since June 2007. The Energy Information Administration reported that crude stockpiles are up by 2 million barrels, to 353.3 million barrels. That was more double the expected increase.