Market rebound: Dow rallies 240 points as rate hike odds dip

Stocks closed sharply higher as investors downgraded the chances of an interest rate hike next week after market-friendly words from a key Federal Reserve official who urged "prudence" and said the case for a "preemptive" hike was "less compelling."

The Dow Jones industrial average closed up 239.62  points, or 1.3%, to 18,325.07, erasing more than half of Friday's nearly 400-point rout sparked by fears of a rate hike next week. The broader Standard & Poor's 500 index finished up 1.5%, or 31.23 points, to 2159.04, shaving off more than half of its 2.45% drp Friday. The technology-packed Nasdaq composite rose 85.98 points, or 1.7%, to 5211.89.

The rally followed a key speech from Lael Brainard, a member of the Fed's Board of Governors. She is considered a Fed "dove," or someone that favors a cautious approach to rate hikes; investors feared Brainard might push for a rate hike next week like other Fed officials have leading up to the meeting. But her commentssuggested that she was still wary of a rate hike next Wednesday.

Fed's Dennis Lockhart: 'Serious discussion' of interest-rate hike needed

After discussing the challenges the global economy faces, in what she called the "new normal," including low inflation in Europe and Asia, Brainard concluded by saying caution in raising rates is warranted. "Today's new normal counsels prudence in the removal of policy accommodation," she said.

Her suggestion that a "preemptive" hike in short-term interest rates is "less compelling" provided the real gas to the stock market rally.

After Brainard's comments the futures market was pricing in just 15% odds of a rate hike on Sept. 21, down from 21% earlier in the day and 24% a day earlier, according to CME Group.

Wall Street pros also dialed back expectations for a rate hike.

"Very slim," were the odds Joe Quinlan, chief market strategist at U.S. Trust, placed on a September rate hike.

Brainard's words on Fed policy were the last before the Fed goes into a quiet period before next week's meeting.

The big rebound on Wall Street followed steep stock market declines in Europe and Asia, where worries about less central bank support for markets prompted investors to sell. The broad Stoxx Europe 600 stock index fell 0.9%. In Asia, Japan's Nikkei 225 index lost 1.7% and Hong Kong's Hang Seng index closed 3.4% lower.

After a quiet summer on Wall Street, where there were no sharp swings in stock prices, volatility picked up Friday when the S&P 500 tumbled nearly 2.5% -- ending a period of calm in which the large-company stock index went 52 trading days without a drop of 1% or more, according to S&P Dow Jones Indices. The Dow also took a hit Friday, tumbling nearly 400 points, which was its worst one-day point loss since late June after Britain shocked markets by voting to exit the European Union.

Stocks tumble amid interest rate worries

Low borrowing costs and stimulus from the Federal Reserve have been a key propellant of stock prices in recent years. The Fed, which hasn't hiked interest rates this year after raising rates back in December for the first time in nearly a decade, meets next week. Wall Street, which wasn't expecting a rate increase until the Fed's December meeting, is now on edge and fears the Fed may move sooner.

On Friday, investors were rattled by comments from Federal Reserve Bank of Boston president Eric Rosengren that raised expectations for a possible rate hike when the Fed concludes its two-day meeting on Sept. 21.

Earlier today, Atlanta Federal Reserve chief Dennis Lockhart, speaking to a business group in Atlanta, said an improving economy calls for a "serious discussion" of a rate increase this year. Lockhart said he expects a "stronger second half" for the economy, but noted that inflation still remains below the Fed's 2% target.

Wall Street did not view Lockhart's comments as a definitive call for a September rate hike, a reason why stocks mounted a rally earlier in the session says Gary Kaltbaum, president of Kaltbaum Capital Management. "Lockhart came out and 'seemed' to roll back a definitive rate hike" next week, he told USA TODAY.

How bank stocks could weather a rate hike from the Federal Reserve

Minneapolis Federal Reserve president Neel Kashkari, who isn't a voting member, was in favor of a more patient Fed, citing still low inflation. "There doesn't seem to be a huge urgency to do anything," Kashkari told CNBC in an interview.

Long-term interest rates, which shot up to their highest levels since Brexit, were moving higher again Monday. The yield on the 10-year U.S. Treasury note, which moves in the opposite direction of price, fell 1.665%, from 1.674% Friday. Earlier Monday, the yield climbed as high as 1.697%.

Investors should expect more ups and downs in the stock market as the Fed meeting nears and the presidential election campaign drags on, says Quinlan.

"Over the near term, stocks are going to be batted around by Fed policy muddle and election uncertainty," Quinlan told USA TODAY.

September and October, he adds, are traditionally volatile months for equities to begin with, "but  this year the degree of volatility will be enhanced."

Contributing: Nathan Bomey and Matt Krantz, Los Angeles