Oh what a beautiful morning, oh what a beautiful day
At Long Last the Fed Gets Help From Stocks, Bonds and Dollar
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- For the first time in two years, Americans may be feeling a bit better about their retirement accounts. Investors are clamoring to lend to debt-laden companies such as Ford Motor Co. and Duke Energy Corp. The rising euro is boosting expectations that the European Central Bank will soon lower interest rates.
These are all signs that, two years behind schedule, the Federal Reserve's monetary medicine is finally working as it should.
When the Fed loosens monetary policy, its most visible action -- lowering the overnight rate banks charge each other on loans -- does only part of the work. Its impact is supposed to be multiplied by rising stock prices, falling long-term interest rates paid by corporations and a weakening dollar. But between January 2001 and last October, as overnight rates plunged from 6.5% to 1.75%, the multiplier effect failed to engage. Stocks kept falling, corporate-bond yields remained stubbornly high, and the dollar actually strengthened, all of which kept the economy sluggish.
But since October, that has been changing. When the Fed first began easing, corporate-bond yields remained stuck at 8% as shrinking profits and an avalanche of accounting scandals increased investors' fears of default. Those fears hit near-panic levels last fall, a major reason the Fed cut its rate target to 1.25% in early November. To stay out of bankruptcy court, corporations responded with radical balance-sheet surgery, paying down debt by selling new stock, selling assets or selling themselves to deep-pocketed acquisitors.
Default fears have subsided dramatically. Since October, the yield on bonds of medium-quality industrial companies has plunged from 8% to 6.4% and once-shunned borrowers have been welcomed back to the bond markets. Jan Hatzius, an economist at Goldman Sachs Group Inc., says there's a tight link between corporate-bond yields and business investment so he's expecting a noticeable pickup in capital spending in coming months.
Now, consider the stock market. Far from the usual rally that follows Fed easing, the Standard & Poor's 500-stock Index, one broad measure of the market, plunged 40% in the 22 months after the Fed's first rate cut. But it is up 20% from its October low. Luxury-car showrooms aren't exactly swarming with "dot-com" entrepreneurs again. But the proportion of consumers who say their retirement prospects have improved in the past 12 months is rising for the first time in two years, according to the University of Michigan. At 22%, the proportion remains far below the 42% of November, 2000, says survey director Richard Curtin. But "the slide has been halted."
Lower U.S. interest rates are supposed to pull down the dollar as investors seek higher returns elsewhere. The problem for most of 2001 and 2002 is that "elsewhere" looked like an even worse investment. Japan was stuck in deflation and recession. Europe was stagnant and emerging economies looked poised to follow Argentina into a financial abyss. As a result, the dollar actually rose 4% against a basket of the U.S. trading partners' currencies. Foreign countries welcomed this since they all counted on exports to the U.S. to prop up their economies, and a stronger dollar made their exports less costly in the U.S. market. But it undercut U.S. manufacturers at home and abroad, forcing them to slash jobs for 33 straight months.
But since last fall the dollar has sunk 7%, half of that in the last week as the Fed's announcement that it in effect thought deflation a greater risk than inflation persuaded currency speculators the Fed may want the dollar to fall to prop up prices. To be sure, a weaker dollar won't reduce competition from China, which ties its currency's value to the dollar. And there are risks: Foreign economies might wilt if their exporters' sales dry up, or panicked investors could dump U.S. bonds, sending interest rates higher.
But a happier outcome could be taking shape. Long-term interest rates have actually dropped along with the dollar, suggesting someone is hungry for the bonds foreigners are now selling. While a weaker dollar may hurt exporters in foreign economies, it will also hold down inflation, and encourage their central banks to lower interest rates. That would stimulate domestic spending and take the pressure off U.S. consumers to keep the world afloat. "We're in an environment of competitive monetary reflation," says David Hale, an independent, Chicago-based economist. "The falling dollar is forcing Europe, Australia, Canada, South America, to either cut interest rates or restrain planned increases in interest rates. There is no doubt this has very strong stimulative effect. In a year we may get a global boom." |
