In a statement, the Fed said it cut the federal funds rate by a half-point to 6 percent and the discount rate by a quarter-point to 5.75 percent. Citing a deteriorating economy, the Fed also said it is prepared to approve a further quarter-point reduction in the discount rate to 5.5 percent.
The moves caught investors off guard because the Fed declined to lower rates last month and it was not scheduled to meet again until the end of January.
After falling in early trading, the Dow Jones Industrial Average jumped 299.60, or 2.81 percent, to 10,945.75 and the Nasdaq leaped 324.82, or 14.17 percent, to 2,616.68. Previously, the Nasdaq's best one-day gain was a 10.5 percent spurt last December.
Volume on the Nasdaq set a record as 3.1 billion shares changed hands. The previous record was set on April 4, 2000, when volume reached nearly 2.9 billion.
"It's a very bullish message for investors," said Alan Skrainka, chief market strategist for Edward Jones. "Moving prior to the Jan. 31 meeting is an important psychological move and reduces the odds of the U.S. economy slipping into recession. I think it shows that the Fed is not going to stand on the sidelines while the economy continues to deteriorate."
Other analysts predicted Wednesday's rate cuts would not be the last.
Does interest rate cut signal recovery?
John Powers, managing director, Robertson Stephens
The rate cut could not have come at a better time, analysts said. Investor sentiment had sunk very low and was made worse Tuesday when the National Association of Purchasing Management (NAPM) released a damning report that its index, a sign of growth in manufacturing, had reached its lowest point since April 1991, when it hit 42.9 percent.
At its last meeting on Dec. 19, the Federal Reserve disappointed investors by leaving interest rates unchanged. Since June 1999, the Fed has raised rates six times for a total increase of 1.75 percentage points. After the last half-point increase May 16, 2000, rates had been left unchanged.
The Federal Reserve's primary mission is to keep inflation under control, and its main weapon is interest rates. When the Fed, which is chaired by Alan Greenspan, senses that the economy is growing at a rate that could ignite inflation, it often raises rates. Conversely, when the economy is looking weak, rates are often cut to make it easier for businesses to finance expansion plans and grow the economy.
In its statement Wednesday, the Fed said the rate cuts were made "in light of further weakening of sales and production, and in the context of lower consumer confidence, tight conditions in some segments of financial markets and high energy prices sapping household and business purchasing power."
Other economic indicators released in recent weeks have reflected the ailing economy. Consumer confidence, which remained at record levels most of last year, recently dropped to its lowest point in two years. Gross domestic product, which rose at a 5.6 percent annual rate in the second quarter, grew at a 2.2 percent pace in the third quarter, its slowest pace in four years.
In the technology industry, computer and chip manufacturers have been plagued by a slowdown in PC sales that led to profit and revenue warnings from several companies in the past two quarters, including Intel, Advanced Micro Devices, Dell, Apple, and Microsoft. For December, retail PC sales plummeted 24 percent in what is being called the worst holiday PC sales season on record.
Tech stocks, which have been in a prolonged slump, surged on the news.
WorldCom rose $3.69, or 23 percent, to $19.63; Sun Microsystems climbed $7.56, or 30 percent, to $33; Microsoft gained $4.88, or 11 percent, to $48.25; and Cisco Systems advanced $8, or 24 percent, to $41.31.
Of the 18 sectors tracked by CNET Investor, Internet e-tailers, server hardware makers and storage companies each gained more than 20 percent.
The CNET tech index rose 278.60 to 2,173.35. Advancers pulverized decliners, with 93 of the 97 stocks in the index rising, three falling and one remaining unchanged.
Earnings warnings, however, prevented some stocks from participating in the rally.
Efficient Networks fell $2.78, or about 23 percent, to $9.53. The maker of digital subscriber line (DSL) equipment warned after the bell Tuesday that its second-quarter revenue would fall short of Wall Street estimates.
Tumbleweed Communications also caught the earnings flu, falling $6.75, or nearly 68 percent, to $3.25, making it the largest percentage loser on the Nasdaq. The software maker warned that fourth-quarter sales would miss analysts' expectations.
Lehman Brothers analyst Daniel Niles lowered earnings estimates for Dell Computer and Intel. Niles cut his 2001 per-share earnings estimate for chipmaker Intel to $1.30 from $1.40 and for Dell, a direct seller of PCs, to $1 from $1.10.
Investors in both companies seemed to ignore the comments. Intel rose $3.16 to $34.22, and Dell jumped $2.50 to $20.
"I think Greenspan showed a lot of leadership," said Peter Kretzmer, an economist at Banc of America Securities. The Fed "determined regardless of what the employment numbers say on Friday that this is what they need to do."
The Labor Department will release unemployment data for December on Friday.
"There is a lot of sentiment management here," Kretzmer said. "Clearly, (the Fed) wants to stop the markets from decaying further and prevent a soft landing from turning into a hard landing for the economy."