Can the Fed stop now?
Neal St. Anthony
Star Tribune
Wednesday, June 27, 2001
What some market watchers believe will be the last of six rapid-fire trims in short-term interest rates is expected today from the Federal Reserve Board.
Observers are split on whether the cut will be a quarter-point or half-point, but the continued weakness in the economy has many expecting the more aggressive move.
"I think we'll get a half-point, a 50-basis-point cut, and it will be the last cut in this economic cycle," Sung Won Sohn, chief economist of Wells
Fargo & Co., said Tuesday. "We expect the economy to pick up steam later this year. Some of the leading indicators, consumer confidence, money
supply and housing, all point to better economic times ahead, even though the jobless rate and capital spending continue to look pretty bad."
The level of the Fed funds rate -- the rate at which banks loan money to each other overnight -- is key because it serves as a benchmark for pricing
many consumer and business loans.
The Fed will announce its decision this afternoon at the end of a two-day meeting.
The rate currently stands at 4 percent, down from 6.5 at the beginning of January. The rate hasn't been lower than 4 percent since the early '90s, when
the country was still emerging from the last recession.
The prevailing mood earlier this spring was that the Fed would lower the rate only by a quarter-point this month, but many now see Fed Chairman Alan Greenspan
continuing an aggressive course.
"Why at this meeting would you downshift the speed of cuts?" Ethan Harris, chief economist at Lehman Brothers, said Tuesday. "There's nothing in the data flow that
suggests we're beginning to see a turn in the economy."
Consumer spending has remained strong, but other indicators have been bearish. Industrial production is near lows last seen in the 1980s and the earnings outlook for
most companies remains poor.
"Corporate profitability is pretty dreadful," said Jay Mueller, chief economist and portfolio manager at Strong Capital Management in Milwaukee. "The capital
spending cycle is still heading down. I think 50 basis points is the right thing to do.
"The Fed has cut 250 basis points already this year. It takes time to work off the debt of the capital spending [technology] boom of the late 1990s and the excess capacity
of the technology companies."
The Fed is not alone in trying to revive the economy. Federal tax cuts and rebates approved this spring are expected to boost consumer spending in the second half of
this year.
But Jane Wyatt, a principal in NorthShore Advisors of Bloomington, a fixed-income investment manager, said the Fed still has justification for being aggressive.
"It's a confidence game," Wyatt said. "I don't think the Fed wants to be identified with targeting the stock market, but they certainly are armed with the economic data
to justify lowering rates again."
Typically, it takes more than six months for interest-rate cuts to take full effect in the economy. Some believe the Fed will simply continue to lower rates until there's
clear improvement in the economy, rather than assume a rebound is coming because of its earlier efforts. The Fed's Open Markets Committee, which determines the
Fed funds rate, is next set to meet in August, though the Fed has sometimes lowered rates between meetings.
Matt Brown, chief equity investment officer at Wilmington Trust in Delaware, said the Fed's aggressive cuts so far will mean an improving stock market in the fourth
quarter.
Brown believes the Dow Jones industrial average has a shot at a record 13,000 by the end of the year. Interest rate cuts are of most benefit to the housing-oriented and
consumer-product companies.
Brian Belski, chief fundamental market strategist at U.S. Bancorp Piper Jaffray in Minneapolis, said even in a stock market recovery, the beaten-down technology
companies that fueled the late '90s market boom will be among the last to see improved profits.
"There will be pockets of technology that will turn positive in the fourth quarter," Belski said. "As a whole, it will be the first quarter of 2002, though."
The semiconductor companies, such as Intel, and the personal computer makers will improve before telecommunications firms, which are caught in the throes of
overinvestment and overcapacity.
"Telecommunications will be among the later-stage areas to turn in the fourth quarter and 2002," Belski said.
Sohn, noting that corporate profits are a lagging indicator, said he expects the Nasdaq to start moving up soon. Investors tend to look at profit expectations six to 12
months out. The earnings comparisons for many companies also will get easier in 2002 after this year's troubles.
"Institutions and individuals have more than than $3 trillion in cash" now, Sohn said. "If we only deploy 10 percent of that, that's going to move Nasdaq up.
"I'm not expecting an explosive rally, but the stars are lining up in the right constellation."
-- Neal St. Anthony is at nstanthony@startribune.com .
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