Stocks recovered from deep losses on Wednesday, amid talk that the Federal Reserve would act to cut the discount rate, the same day that Merrill Lynch rattled markets with its first loss in nearly six years.

Earlier in the session, the S&P 500 sank to its lowest since September 18, when the Fed cut interest rates by half a percentage point in a move to provide relief in an increasingly tight credit environment.

A Fed spokesman declined to comment on the market speculation.

Merrill, the world's largest brokerage, reported a $2.3 billion loss and eye-popping write-downs of $7.9 billion for bad bets on mortgages and leveraged loans. Standard & Poor's cut Merrill's credit rating, helping to send the stock to its lowest since October 2005.

Shares of Merrill sank 5.6 percent to $63.34.

In a conference call with analysts, Merrill's executives said further challenges could disrupt credit markets.

There's been a lot of rumors about the Fed possibly lowering the discount rate, an emergency meeting or even lowering the Fed funds rate, said Neil Massa, senior U.S. trader at MFC Global Investment Management, in Boston. But the Fed's in a quiet period, so that's very unlikely. But that's what turned the market.

The Dow Jones industrial average (.DJI: Quote, Profile, Research) was down 40.81 points, or 0.29 percent, at 13,635.42. The Standard & Poor's 500 Index (.SPX: Quote, Profile, Research) was down 9.21 points, or 0.61 percent, at 1,510.38 after earlier dipping as low as 1,489.56. The Nasdaq Composite Index (.IXIC: Quote, Profile, Research) was down 36.84 points, or 1.32 percent, at 2,762.42.

The Dow was earlier down as much as 1.5 percent and the Nasdaq slumped as much as 2.65 percent.

(Additional reporting by Kristina Cooke)