Fed Sees Risk of `Economic Weakness'; Holds Rates
By Noam Neusner
Washington, Dec. 19 (Bloomberg) -- Federal Reserve policy- makers announced for the first time in two years that further ``weakness'' is a bigger threat than inflation to the U.S. economy, signaling they will cut interest rates soon.
For now, Fed Chairman Alan Greenspan and other members of the Open Market Committee let the overnight bank lending rate stand at 6.5 percent, the fifth straight time they've done so since May 16, when they raised borrowing costs.
``Eroding consumer confidence, reports of substantial shortfalls in sales and earnings, and stress in some segments of the financial markets suggest that economic growth may be slowing further,'' the FOMC said in a statement accompanying its decision.
The Fed's statement ended any doubt about whether it would begin to cut rates. ``This is fair warning,'' said Bill Quan, senior economist at Aubrey G. Lanston & Co. in New York. ``The decision is not whether or not they'll ease, but when.''
In addition, the Fed indicated that inflation concerns -- which guided policy for the past 18 months -- have been superseded by an economy that is slowing more than it wanted.
Slower Growth Rate
The economy expanded in the third quarter the slowest pace in four years. Retail sales fell in November, the first decline in seven months. Industrial production fell in October and November. Other than during a strike at General Motors Corp. in 1998, the last time production declined two months in a row was in 1991, at the end of the last recession.
Today's announcement included a paragraph that the Fed crafted a year ago in its effort to clarify its statements to the public following interest-rate policy meetings. The Fed prepared three such paragraphs, one that said the risks to the economy are weighted toward inflation, one that said the risks are weighted evenly between inflation and economic weakness and one that says weakness is the biggest threat.
For the first time since it started using this new language, the Fed used the third option today: ``Against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the Committee consequently believes that the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future.''
That means ``the economy is slowing faster than desired,'' said Sung Won Sohn, chief economist at Wells Fargo & Co. in Minneapolis. ``The economy could be in a recession, after all, the beginning of a recession is the end of a boom when things feel pretty good. Unless the downward momentum is slowed, the economy could slide into a recession.''
1998 Crisis
The last time the Fed signaled that it was concerned that the economy was poised to fall into recession was in 1998, when a global financial crisis threatened to strangle markets and investor confidence. Central bankers also cut the overnight bank rate in three quarter-point steps in September, October and November of that year after Russia defaulted on its debt and many countries in Asia and Latin America had slipped into recession.
The Fed also said it will ``continue to monitor closely the evolving economic situation,'' which some economists said is a sign that if prices don't accelerate in the coming weeks, a rate cut is a sure thing at the Jan. 31 meeting, or even before.
``The Fed is all but telling us there will be a rate cut in January,'' said Cary Leahey, senior U.S. economist at Deutsche Bank Securities Inc. in New York.
Stocks and Treasury securities fell following the announcement, which disappointed investors who had bet on a rate cut. The Dow Jones Industrial Average fell 61 points, or 0.6 percent, after having been up 139 points earlier. The Nasdaq Composite Index fell 113 points, or 4.3 percent, having been up 72 points earlier. The Treasury's 10-year note fell 1/8 point, pushing up its yield 2 basis points to 5.19 percent.
`A Compromise'
``We were disappointed they didn't go all the way,'' said Chris Rupkey, a senior financial economist at Bank of Tokyo- Mitsubishi Ltd. in New York. ``The decision looks to be a compromise between neutral risk hawks and rate cut doves. The Fed risks shooting themselves in the foot by not moving more forcefully.''
Dozens of companies, ranging from household goods maker Whirlpool Corp. to No. 1 software company Microsoft Corp., have warned that a slowing economy is hurting their earnings and revenue growth.
Gillette Co., which has lowered earnings or sales forecasts seven times in the past 18 months, said it will fire 2,700 employees, or 8 percent of its workforce, and close eight factories to cut costs. Aetna Inc., the No. 1 U.S. health insurer, said it will cut about 5,000 jobs. General Motors Corp. said it will close its Oldsmobile division and cut 15,000 jobs over several years.
Earnings Warnings
Many U.S. companies forecast their smallest quarterly earnings growth in two years and analysts say profits may fall by July. Fourth-quarter profits for companies in the Standard & Poor's 500 Index will rise 7.7 percent, according to estimates compiled by First Call/Thomson Financial.
Companies ranging from Microsoft Corp. to Chase Manhattan Corp. lowered profit estimates, and the number of reduced forecasts has risen 70 percent from a year ago, said Chuck Hill, First Call's research director.
The quarter is likely to be the worst for profits since late 1998, when earnings rose 6 percent after Russia defaulted on its debt and the New York Fed Bank stepped in to rescue the hedge fund Long-Term Capital Management.
``For the first time in five years, both old economy and new economy production are slowing together,'' said Neal Soss, chief economist at Credit Suisse First Boston in New York.
Company profit warnings have cooled investor optimism. Major U.S. stock indexes, whose rise in recent years prompted Fed concerns that consumer demand would overwhelm the economy's capacity, have struggled as earnings concerns have spread. The Wilshire 500 Index is down 13 percent so far this year. The Dow Jones Industrial Average is down 8 percent. The Nasdaq Composite Index, composed mostly of computer, software and technological equipment makers, is down 38 percent.
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The Fed has made a grave mistake in my opinon.
Best Regards, J.T. |
