Investors expect the move to drive down borrowing costs for everything from mortgages to credit cards. The Dow Jones industrial average reversed early losses to end up 91 points and the yield on the benchmark 10-year Treasury note plunged, indicating strong demand for the note.
The dollar fell as investors worried the government's actions would eventually fan inflation.
The Fed's move, analysts said, is likely to produce an immediate drop in mortgage rates, of 0.25 to 0.5 percent percentage points. The central bank also made clear it would be able to purchase the majority of new mortgage-backed securities for at least the rest of the year, possibly longer.
That's great news for those borrowers with good incomes and healthy credit scores who are able to qualify for a loan. But dramatically tighter lending standards have made it tough for many borrowers to qualify.
Still, it was a plus for the housing industry, which many analysts believe must recover in order for the overall economy to prosper again. Homebuilder and financial company stocks shot higher on the news, which came a day after the Commerce Department reported better-than-expected housing start numbers for February.
The sheer magnitude of the Fed's proposal "indicates they have a lot of weapons still in the arsenal," said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland.
The Fed said it would build on a plan to buy mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac. It also will buy an additional $750 billion, bringing its total purchases of these securities to $1.25 trillion. It also will boost its purchase of Fannie and Freddie debt to $200 billion.
The Fed's announcement accompanied its decision to keep interest rates at historically low levels. Chairman Ben Bernanke has said in recent weeks that the recession could end this year if the credit and financial markets can be stabilized. Bernanke and other officials have said they would deploy whatever tools necessary to revive the economy.
"They are certainly, assertively doing everything they can to intervene," said David Darst, chief investment strategist of Morgan Stanley's Global Wealth Management Group.
The Dow Jones industrial average rose 90.88, or 1.2 percent, to 7,486.58.
Broader stock indicators also jumped. The Standard & Poor's 500 index added 16.23, or 2.1 percent, to 794.35, and the Nasdaq composite index rose 29.11, or 2 percent, to 1,491.22.
The Russell 2000 index of smaller companies jumped 14.04, or 3.5 percent, to 417.63.
More than four stocks rose for every one that fell on the New York Stock Exchange, where consolidated volume came to a heavy 9 billion shares compared with 6 billion shares traded Tuesday.
The market had traded lower ahead of the Fed's decision. Stocks have risen for six out of the last seven days. Since the market rally began last week, the Dow has jumped 14.4 percent, and the S&P 500 has soared 17.4 percent. Those are the types of gains that would normally make for a great year in the stock market.
Government bond prices surged. The yield on the benchmark 10-year Treasury note, which moves opposite its price, tumbled to 2.50 percent from 3.01 percent late Tuesday. The yield on the three-month T-bill, considered one of the safest investments, slipped to 0.20 percent from 0.22 percent late Tuesday.
The dollar fell against other major currencies. Gold prices also slid as demand for safe haven holdings fell.
For both the stock and bond markets, the Fed's announcement was a welcome surprise. After the last Fed meeting in January, policy makers said they were considering buying government debt. But investors were skeptical the Fed would actually go through with it.
"We've suffered over the last month or so with disappointment that a lot of the initiatives out of the administration haven't materialized, and here is the Fed moving in with very strong actions to get things back on track," McCain said.
The Fed move - which economists call "quantitative easing" - is another way to push interest rates lower by essentially adding more money to the financial system. The Fed is using this tool now since its other main policy lever, the federal funds rate, has already been ratcheted down as low as it can go.
Bank stocks - including Citigroup Inc., Bank of America Corp., Wells Fargo & Co. and JPMorgan Chase & Co. - got an extra boost after the Fed announcement. The Fed's actions are intended to keep interest rates low and also to unfreeze borrowing activity, which could be a huge help for banks.
Citi and Bank of America each jumped more than 22 percent, while Wells Fargo rose 17.5 percent and JPMorgan added 7.8 percent. Home builders put up huge gains as well. Hovnanian Enterprises Inc. jumped 50 percent to $1.44, while Toll Brothers Inc. rose 5.7 percent. Home improvement retailers jumped as well. Home Depot Inc. rose 5.1 percent and Lowe's Cos. added 4.7 percent.
Technology stocks rose on news that International Business Machines Corp. is in discussions to buy Sun Microsystems Inc. for at least $6.5 billion in cash. Sun skyrocketed 79 percent, rising $3.92 to $8.89. IBM fell 96 cents, or 1 percent, to $91.95.
Investors are growing more hopeful that the rally in stocks might have staying power, though many remain cautious. Stocks gained 20 percent from late November until the start of the year, only to come crashing down to levels not seen in more than a decade as worries grew about the stability of the financial system and the economy's ability to turn higher.
As the Federal Reserve announced its plans, Capitol Hill focused on the millions of dollars in bonuses American International Group Inc. recently granted executives. AIG is roughly 80 percent owned by the government after receiving billions in federal bailout money.
President Barack Obama said he is seeking greater regulatory authority over financial institutions like AIG. Obama said the new powers he is seeking would be similar to those now exercised over banks by the Federal Deposit Insurance Corp. It would be part of the broader financial regulatory steps the administration is creating.
AIG rose 44 percent to $1.38.
Meanwhile, an unexpected build in gasoline inventories helped send oil prices lower. Light, sweet crude fell $1.02 to $48.14 per barrel on the New York Mercantile Exchange.
Overseas, Britain's FTSE 100 fell 1.4 percent, Germany's DAX index rose 0.2 percent, and France's CAC-40 fell 0.3 percent. Japan's Nikkei stock average rose 0.3 percent.
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