FED WATCH: Weak Stocks Revive Rate Cut Talk, Again
23 Jul 08:00
By Michael S. Derby
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--The seemingly endless tumble into the abyss suffered by
the equity markets is keeping hopes alive in some quarters that the Federal
Reserve will ride to rescue with yet another interest rate cut to end the
pain.
While few economists agree any such actions is either imminent or likely, the
impact of such a cut would be primarily as a salve to investors' shattered
nerves, and would be aimed at keeping stock losses from worsening to the point
that they'd harm the otherwise health U.S. economy.
For the Fed to cut rates now, it would be "purely psychological. At this
stage and at this level of rates you are not looking at actually adding to the
real economy" with such a policy shift, said Drew Matus, economist at Lehman
Brothers in New York.
Even a "purely psychological" move would be hard to justify, given that it
falls outside the Fed's mandate, while the real economy shows no need for
further monetary stimulus.
Indeed, most economists agree that based on the performance of the real
economy, there's no need for lower interest rates. Already, the overnight fed
funds rate of 1.75% is at a 40-year low, and is down from 6.5% at the beginning
of 2001.
A survey of most of the economy outside of the financial markets is fairly
positive and shows an economy that is shaking off last year's recession. While
the corporate sector is still troubled, consumer spending has remained robust -
retail sales rose 1.1% in June - and the much battered industrial sector's
output continues to improve. Also, the employment sector has begun to firm,
albeit in a slow fashion.
But those same economists all agree that the economy's prospects remain
fragile. They're concerned that if stocks continue to wither away it will cause
the rest of the economy to suffer, as consumersrattled by their shrinking
retirement accounts cut back on spending. And with businesses still not
contributing to growth at the levels most economists would like to see, such a
pullback could force the economy back into recession.
So as is so often the case, a rate cut now would be a play for confidence by
the Fed. Investors have found some hope in precedent, given that the central
bank cut rates in the fall of 1998 and in the wake of Sept. 11 - each time in a
bid to shore up sentiment around markets that were facing significant threats
to their smooth functioning.
The difference this time is that while stocks have lost a huge chunk of their
total value this year, the selloff has been orderly. They system continues to
function, and that's the Fed's paramount concern, especially since the rest of
the economy is holding together, economists say.
Blowback
With few economic benefits to be had, some warn cutting rates now might
actually hurt confidence levels and worsen the downward spiral, spreading the
fear held by equity investors into the broader economy.
Last week Fed chairman Alan Greenspan offered no signals that the Fed is
viewing the financial market losses as a threat to growth. He told Congress
that while uncertainty still surrounds the economy's prospects, "the
fundamentals are in place for a return to sustained healthy growth," and he
suggested the current scope of low rates will eventually be incompatible with
expected growth levels.
Greenspan also downplayed the role stocks play in most houses' overall worth
by flagging the more enduring impact that rising home values have for most
Americans.
The Fed chairman "signaled last week that he's pretty comfortable with the
performance of the economy," said David Greenlaw, economist with Morgan Stanley
in New York. Lowering rates now "would be inconsistent" with that message, and
that sudden shift would likely be seen as panicky and would exacerbate the
market's current woes,he said.
-Michael S. Derby, Dow Jones Newswires; 201-938-4192;
michael.derby@dowjones.com
(END) DOW JONES NEWS 07-23-02
08:00 AM |
