"U.S. Economy: Fed Rate Cut May Be Less Than Investors Desire"
03/19 00:01
By John Cranford
Washington, March 19 (Bloomberg) -- Federal Reserve policy makers will be watching economic statistics, not stocks, when they decide how much to cut borrowing costs tomorrow. That's why investors aren't likely to get the three-quarter-percentage-point reduction they want in the Fed's benchmark interest rate.
Investors began clamoring for such a rate cut after the Dow Jones Industrial Average fell 7.7 percent last week, its worst weekly drop since October 1989. The Nasdaq Composite Index, down 23 percent for the year, has dropped for seven straight weeks.
At the same time, economic reports show U.S. consumer confidence is no longer falling, steel production is rising, auto sales aren't as weak as had been feared, and home construction and sales just won't quit.
Growth is ``decently positive, and the Fed is focused on the real economy,'' said David Jones, chief economist at Aubrey Lanston & Co in New York. ``The last thing a central banker wants is to be perceived as someone bailing out the stock market.''
After two interest-rate cuts from the Fed in January that totaled a full percentage point, some parts of the economy such as manufacturing continue to struggle. Industrial production fell for a fifth straight month in February, the longest string of declines since the 1990-91 recession.
That's why economists and investors are counting on Fed Chairman Alan Greenspan and his colleagues, at their policy meeting tomorrow, to cut the target rate on overnight loans between banks at least a half point from the current 5.5 percent.
Fed Sees Growth Pickup
In recent public comments, Fed officials said they see growth picking up later this year. ``There are clearly some signs that might suggest strengthening and some signs that suggest the risks are still to the downside,'' Fed Vice Chairman Roger Ferguson said last week in Rome. ``We've got to be fairly cautious about calling anything prematurely here.''
Although consumer confidence was lower in January than at any time in more than four years, a measure of optimism from the University of Michigan was revised higher at the end of February from a preliminary estimate in mid-month. The mid-March consumer sentiment result was even higher.
Home resales rose 3.8 percent in January and home construction starts last month were on a pace close to that of all of last year, the third best since 1987. U.S. raw steel production has been rising since January, when it slumped to a decade low. Weekly steel production is now higher than any time since mid- October.
Vehicle Sales
Vehicle sales in February were stronger than expected and put 2001 on pace to be the third-best year on record, surpassing forecasts made at the start of the year. The annual new car sales rate of 17.5 million for the month was higher than January and showed that lower consumer confidence and falling stocks weren't leading consumers to put off car buying.
If policy makers do cut by three-quarters of a point tomorrow, the overnight rate will fall to 4.75 percent. It will then be back where it was on June 29, 1999 -- the day before the Fed began a series of six rate increases to prevent the economy from overheating. In less than three months, the Fed would have wiped out actions that took 11 months to put in place.
The rate increases of a year ago had their desired effect - - and then some. The economy cooled to a 1.1 percent growth rate in the final three months of last year, after expanding at an average 6.1 percent pace in the 12 months from July 1999 through June 2000. Greenspan told Congress last month the abruptness of the slowdown is why Fed policy makers ``quickened the pace'' of interest-rate cuts in January.
Manufacturing and Inventories
Greenspan and other Fed policy makers have characterized the slowdown as mostly affecting manufacturing and mostly the result of companies trying to work off excess inventories.
Even so, the drop in stocks may be the cause of broader weakness in the economy, said David Wyss, chief economist at Standard & Poor's in New York, who expects a three-quarter-point cut. Greenspan's job ``isn't to save the stock market,'' he said. ``It's to save economy from the stock market.''
Ten of the 25 bond dealers who trade directly with the Fed changed their forecasts last week to a three-quarter-point cut as stocks slid further. Trading in federal funds futures shows investors expect the overnight rate to average 4.82 percent in April -- almost three-quarters point below the current rate.
``The Fed tends to give the market what it wants and the market is clamoring'' for a three-quarter-point reduction, said Cary Leahey, senior economist at Deutsche Bank Securities Inc. in New York.
Stocks May Fall
Stocks probably will fall if policy makers cut by just a half point, though it might be only a temporary disappointment, Jones said. Worse would be if the Fed cuts three-quarters of a point and stocks still drop further, he said. ``Then you've shot your ammunition.''
Jones said it would be smarter for Greenspan to cut by a half point tomorrow and then perhaps by a quarter point some time in April -- before the Fed's next policy meeting in mid-May. ``It seems to me, that preserves his options,'' Jones said.
A three-quarter-point cut might also look like a panic step. During Greenspan's more than 13 years as Fed chairman, the central bank has never cut the overnight rate so much in one day.
Central bankers came close to such a move in December 1991, as the economy was trying to dig out of the last recession. In a two-week period, the Fed chopped the overnight rate from 4.75 percent to 4 percent. That same month, the central bank cut its more symbolic discount rate on direct loans to banks by a full percentage point in one day.
Even Wyss said a larger rate cut poses a risk for the Fed that investors will start counting on it to always meet market expectations. ``If the Fed does three-quarters, they'll be disappointed when the Fed doesn't do three-quarters the next time.''
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