As expected, the Fed cut a key short-term interest rate on Tuesday. But the quarter-percentage-point reduction wasn't as big as many traders had been hoping for, and share prices nosedived in the afternoon before recovering some of the lost ground just ahead of the closing bell.
The slight rebound suggests that investors realize they'd been pushing their luck in expecting the Fed to wantonly slash rates in Xena-like fashion, and that many on Wall Street are prepared to take a longer-term view of the market's prospects.
The Wired Index ultimately fell 1.60 points to close at 394.80. The Dow Jones Industrial Average ended 28.32 lower at 8080.52 after being down nearly 100 points right after the Fed's announcement.
The policy-making Federal Reserve Open Market Committee voted to lower the federal funds rate -- an overnight bank lending rate that serves as a benchmark for short-term interest rates -- to 5.25 percent from 5.5 percent. The committee said in a statement that the move was intended "to cushion the effects of international weakness on the US economy."
However, many on the Street had been keeping their fingers crossed for a full half-percentage-point rate cut, and sentiment was running strong by mid-morning that anything less just wouldn't do the trick.
Chuck Thomas, research director for JW Genesis Capital Markets, said traders were only setting themselves up for disappointment by expecting anything more than a quarter-percentage-point reduction. The Fed seldom has been known to act with greater boldness, he pointed out.
"A half a point is unheard of for these guys," Thomas said. "Anything too large sends red flags that the world is worse off than we think it is."
While conceding that the impact of a quarter-percentage-point lowering is "purely cosmetic" in light of the relative health of the US economy, he added that the Fed undoubtedly plans to gauge the response to this new move -- its first rate cut since January 1996 -- and to follow up with additional reductions as needed.
Lower US rates add liquidity to the world financial system, but they can also turn up the heat for troubled economies abroad. In Japan, for example, interest rates are now about as low as they can go. If dollars become too cheap, this could unduly strengthen the yen and exacerbate efforts to reform the country's debt-soaked banking industry.
On the other hand, a gradual reduction in US rates should encourage American consumers to keep spending and businesses to keep investing. This could provide a much-needed shot in the arm for economies in Asia, Russia, and Latin America, which would in turn alleviate much of the instability that has come to dominate global financial markets.
Many analysts believe that is what Fed chief Alan Greenspan has in mind, and that interest rates could be as low as 4 percent within a year.
"The big shoe out there waiting to drop is a devaluation of the Chinese yuan," Thomas said, adding that Tuesday's rate cut might help forestall that eventuality by allowing US consumers to purchase more goods from China. Certainly that's what Greenspan & Co. are hoping will happen.
Stocks traded in a narrow range until the Fed's announcement, with most investors cooling their heels until receiving the word from on high. Much of the early activity was confined to the tech sector, which was rocked by a profit warning from computer retailer PC Connection. The company's shares plunged more than 50 percent after saying third-quarter earnings will be far below analysts' expectations.
Dell Computer (DELL) slipped 25 cents to $67.81. Intel (INTC) held steady, advancing $1.44 to $88.44, and Microsoft (MSFT) finished the day up $1.50 at $112.81.
PeopleSoft (PSFT) surged $2.19, or 7 percent, to $33.50 after Standard & Poor's Financial Information Services said the business application maker would replace First Chicago on the S&P 500 Index. The change takes effect after 1 October, when First Chicago merges with Bank One, already an index component.
On the Internet front, America Online (AOL) and Yahoo (YHOO) posted gains as SG Cowen handed a "strong buy" rating to both companies' stock. AOL rose 44 cents to $117.56, and Yahoo gained $3.56 to $131.50.
Investors reacted warily to news from Incyte Pharmaceuticals (INCY) that the biotech company's board had adopted a "stockholder rights plan" intended to protect shareholders from unwanted takeovers. Incyte's stock shed $1.63 to $22.13.
Analytical instrument maker Thermo Electron (TMO) slipped 13 cents to $15.69 as several subsidiaries announced layoffs and charges as part of ongoing restructuring efforts. ThermoSpectra said it will lay off 17 percent of its workforce and take a $5.4 million charge, while Thermo Instrument Systems said it would cut as many as 700 jobs and take a $28 million charge. Thermo TerraTech will take a $10 million charge.
The Nasdaq fell 5.17 points to 1734.05, while the S&P 500 rose 0.33 to 1049.02.
