Wall Street Holds Its Breath
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Monday March 19, 5:40 pm Eastern Time
SmartMoney.com - The Economy
By Rebecca Thomas
<<TUESDAY IS THE biggest day in the history of the Federal Reserve.
OK, we're exaggerating. But that bit of hyperbole captures the prevailing mood on Wall Street heading into Tuesday's meeting of the Federal Open Market Committee. Although the central bank seems inclined to make only a moderate interest rate cut given the surprisingly resilient economy, investors are demanding a major slashing. And if the Fed disappoints these overblown assumptions, it could be another rocky day — or week, or month — for stocks.
Most economists expect the Fed to go the cautious route, cutting the benchmark federal-funds rate by one-half of a percentage point, to 5.0% from 5.5%. But Wall Street's cries for a bigger cut are almost deafening.
Although the Fed under Chairman Alan Greenspan has changed rates by three-quarters of a point only once before — when it raised them in 1994 — the April federal-funds futures contract now puts the likelihood of a 75-basis-point cut at 60%. While that number looks staggeringly high, it's actually down from a 75% expectation early last Friday, before the market essentially ignored a benign producer-price-index report and weak industrial production data and fixated on the University of Michigan's consumer sentiment index. While the inflation and manufacturing data could have been seen as providing both some leeway and some added justification, respectively, for a bigger rate cut, the surprisingly strong consumer confidence number pointed in the opposite direction. The March reading of 91.8, up from 90.6 last month, beat expectations of 88 — prompting traders to worry that the Fed, which is thought to watch such gauges carefully, would conclude that confident consumers won't curb spending as much, meaning there's less need for aggressive rate cutting.
Greenspan, for his part, has been relatively upbeat lately about what seems to be an improving economy. When he testified before the Senate and House on monetary policy last month, he noted that the exceptional economic downturn late last year ``seemed less evident in January and February.''
Indeed, for every negative statistic, there seems to be a positive one to balance it out. For example, while layoffs are indisputably on the rise, workers are still finding new jobs relatively quickly. In February, companies added a much-more-than-expected 135,000 new jobs, while the unemployment rate remained at a tight 4.2%. Moreover, while February retail sales were off a bit from January, they were still better on a year-over-year basis than the November and December figures.
Nevertheless, the camp supporting a bigger rate cut is as vocal as ever. Bear Stearns chief economist Wayne Angell, who gained notoriety last month when he put the odds of an intrameeting cut at 80%, argued on this week's ``Fox News Sunday'' that a full-percentage-point cut was necessary. Senate Minority Leader Tom Daschle (D., S.D.), meanwhile, called for a cut bigger than a half point on Sunday's ``Meet the Press.''
In the absence of miserable economic news, it's clear that the falling stock market has become the biggest concern for economic and political pundits alike. The further the market falls, the more aggregate wealth is lost, and the greater the likelihood that Americans will rein in their spending — perhaps enough to produce the very sort of dismal economic numbers we've avoided thus far.
Equity-owning Americans certainly have reason to feel poorer than they were a year ago. Stocks have fallen like dominoes since the Fed last cut rates on Jan 31. The Nasdaq Composite has lost 882 points, or 32%, since then, and is now in its worst bear market ever, off 63% from its peak last March. The Dow Jones Industrial Average, meanwhile, has fallen 1,064 points, or 10%, and is now below 10000 for the first time since October. The broader S&P 500 index, which has shed 16% since the last rate reduction, is mired in its first bear market since 1987. And the weakness appears to be intensifying heading into the FOMC meeting: The Dow lost 8% last week, its fourth-worst performance since World War II (the worst being the memorable 13% plunge in the week ended Oct. 23, 1987).
But while the market's impact on consumer confidence — and ultimately spending — is certainly worrisome, the Fed doesn't want to be perceived as bailing out stock investors. Explains Pierre Ellis of New York consulting firm Decision Economics: ``The Fed doesn't want to encourage people to take risks in the stock market in the belief that policy makers will always save them.'' Only if the Fed believes the financial system is ``in some way threatened'' would it feel pressured to ease rates by more than one-half point, he says.
Still, the Fed can't afford to ignore the market's pleas for help. If policy makers don't satisfy Wall Street's demands, there's a risk that disappointed investors will continue dumping stocks, further eroding the wealth effect that helped fuel the late-1990s economic boom. Already, investors have lost an eye-popping $4 trillion since the market peaked last March. And with nearly half of all U.S. families now owning stock either directly or through mutual funds, that negative wealth effect is clearly starting to hit home. Household net worth declined in 2000 for the first time in 55 years, according to the Federal Reserve's most recent ``flow of funds'' report. This measure of assets such as homes and stock portfolios minus liabilities such as mortgages fell 2% in 2000, with most of the drop due to falling stock prices.
And while consumers haven't stopped spending yet, that could change quickly if the stock market continues its dramatic fall. ``An improvement in equities is a necessary condition for an economic recovery,'' says Lehman Brothers chief economist Stephen Slifer. ``The Fed is certainly interested in the equity markets; they just can't tell us that.''
So what will the FOMC do? ``The bottom line,'' says UBS Warburg economist Jeffrey Palma, ``is that it's a very close call.''>> |
