The Daily Interview: The Fed Was Wrong, Says Froehlich
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Wednesday March 21, 7:52 am Eastern Time
TheStreet.com - Fund Watch 1
The Scudder official says a deeper cut would have been a catalyst.
By Lee Barney
Staff Reporter
<<Some people are ... let's say, disappointed, with the Fed's decision.
An expectant mood on Wall Street early in the day was stomped out after the Federal Open Market Committee decided to cut the fed funds rate by 50 basis points -- less than the 75 basis points hoped for by many. The news took the modest wind out of the market's sails: The Dow ended down 239 points to 9720 and the Nasdaq lost 94 to 1857.
Among the nonplussed is Robert Froehlich, vice chairman of Scudder Investments . In an extra Daily Interview, Froehlich said that 50 basis points isn't enough to revive the markets. In fact, he was hoping the Fed would grant the markets a cut of as much as 75 or even 100 basis points.
Froehlich also believes the Fed dropped the ball last year by raising rates too aggressively, and that it messed up again today by missing a chance to provide a sufficient spark to the markets and the economy. For more on how he really feels about the Fed, and the market outlook, read on.
TSC: Why were you hoping that the Fed would cut the rate by 75 basis points, or possibly even 100?
Froehlich: We've already had so much negative reaction in the market with the S&P and Nasdaq in bear market territory. The Federal Reserve Board should have known they have to do something dramatic to change the cycle. We could have finally seen the bottom of the market, had the Fed gotten aggressive and cut the rate by 75 or 100 basis points. I just don't think the cycle will change with just a 50 basis-point cut.
We could continue to be locked in a lateral market, unless the Fed decides to act ahead of the next Federal Open Market Committee meeting and cuts the rate some more. They are behind the curve. We really needed a 75 to 100 cut, and the market is already responding downward, telling us that's what should have happened.
There is no argument from anyone that business spending and consumer spending has slowed down. That has caused the economy to slow down, which in turn has caused corporate earnings to slow down, which in turn has caused stock prices to fall. Because of those falling stock prices, it feeds right back in to consumers and businesses spending even less money. So, we are caught in this vicious cycle.
What it takes to come out of that cycle is a dramatic event that can lift business and consumer confidence to get businesses and consumers to spend more, which causes the economy to grow more, which makes profits grow, which makes the stock prices grow. We actually could have reversed this cycle with a 75 or 100 basis-point rate cut because that would have prompted the economists to start changing their forecasts and begin saying that the economy is looking a whole lot brighter.
I'm afraid that now that this has not happened, this market is going to be locked in the trading range it has been in the last year and a half. I am surprised that the Fed did not realize this.
TSC: Some market watchers believe the Fed does not want to be led by the market and that's why it did not pander to it with a larger cut.
Froehlich: In fact, the Fed does not lead the market, the market leads the Fed. The Fed should realize that it's now the year 2001, not the year 1980. In the 1980's when you didn't have every individual all around the globe investing in the markets, the Fed could pretty much lead the market. They can't lead the market anymore because of the globalization of all of the markets, because of the technology and the information trading so fast. If they weren't being led by the market, then why would Alan Greenspan have ever mentioned the term "irrational exuberance?"
Even though the Fed may say it's looking at monetary policy, not at the market, that isn't so. It's the market that really drives the end of the cycle, because when the market's down, I can tell you, businesses aren't going to spend money and neither are consumers. So you can pretend that you are working on monetary policy in a vacuum, but that's just not reality.
Yesterday's opportunity for a 75 basis-point or 100 basis-point rate cut would probably have been the single most effective Federal rate cut of the past 10 years. That's how critical the crossroads are that we are at today. It was probably the single most important meeting of the Federal Open Market Committee of the past 10 years, far more important than the Southeast Asian crisis and Long Term Capital Management .
TSC: You are well known for being very bullish. But now that we did not get the catalyst you were hoping for, do you see any other potential catalysts for the economy?
Froehlich: We have two things working for us now. While it's not as dramatic as I would have liked, we at least have got the falling interest rates. The price of energy, particularly the price of oil, is also falling.
If you go back to what was the major impetus that got not only our economy in trouble but the economies of the world in trouble, it was a combination of every central bank, including that of the United States, raising interest rates right in the face of the price of energy tripling. You can't raise interest rates and let the price of energy triple -- which is the same as a tax hike -- around the world and then wonder why the economy slowed.
We've gone full circle now. It's just the opposite happening. We are watching central banks around the world now cut interest rates and the price of energy drop. The fundamental backdrop is different today than it was 18 months ago, when it got us in trouble. So, I think we are headed for positive territory over the next two years.
TSC: So the Federal Reserve, and the banks that followed suit, were mistaken in raising interest rates in the first place?
Froehlich: Absolutely, positively. No doubt in my mind. The Federal Reserve Board and all of the banks that followed were focusing on the wrong thing. They were focusing on inflation and unfounded fears that our economy was growing too rapidly at 5%, 6% and the fact that everyone who wanted a job could get a job. I don't understand how that could be bad. The banks were fighting something that isn't the enemy -- something that just wasn't there.
Because the banks raised interest rates, while at the same time watching energy prices go up, we had a debacle in the markets. The Federal Reserve started raising rates in June of 1999 and continued to raise them a total of six times over the next 18 months. Two hundred central banks around the world followed us.
That's one of the reasons I was truly hoping the Fed was going to be extremely aggressive yesterday. Everybody knows when you're right and when you're wrong, and the market clearly knows the Fed made a mistake. No one's perfect. Sometimes you're going to be right and sometimes you're going to be wrong. This is a case where they happened to be dead wrong. They were dead right in the Southeast Asian currency crisis, so it's not like we don't have a good Federal Reserve Board. But they are not immune to making mistakes, and I believe that because they know they caused this slowdown, they are at least going to grant us additional rate cutes to get us back on the right track.
TSC: What do you foresee for the rest of 2001?
Froehlich: It takes about six to nine months for changes in monetary policy to work their way into the economy. What we're seeing is the lagging impact of those interest-rate hikes, and they are now working their way into the economy.
The exciting thing for individual investors, I think, is that we've already had two interest rate cuts of 50 basis points this year, and since Jan. 1, there's been 38 other central banks around the world cutting interest rates. So I think we have a very positive outlook going forward, once we can get businesses and consumers to start spending money again, which I think they will.
We are also going to see an explosion in mortgage refinancing, and that has a great ripple effect on the economy. What happens when someone refinances their mortgage? Not only do their payments fall but they end up buying that new refrigerator or that new stereo or big-screen TV. I think we are right at the beginning of that thing starting to peak.
I would even say that I believe the markets will do well throughout the decade for three reasons. First, let's not forget that we now have a government budget surplus. That's huge. We are projecting that 10 years out the U.S. is going to have a $2.2 trillion budget surplus, and the key is, when the government stops competing with the private sector for capital, more capital flows to business. And when more capital flows to business, more jobs are created and the economy is lifted. That's an extremely important fundamental factor.
We also have a global market, which means that competition is everywhere. A good business can sell its products virtually everywhere, which forces every business to get leaner and meaner and more profitable because they don't know where their next competitor is going to come from. It could be Mexico, South Dakota or China. This is beneficial to investors.
Finally, demographics are going to continue to force the hands of investors to stick with the markets. We've got 76 million Baby Boomers who are now heading into their peak earnings, saving and investing years. I think we are about to see a real uptick in savings and investing in the United States, not because the market is so good, or because we have so many great financial advisors, but simply because demographics is finally going to play in our favor as so many people hit their peak earnings and savings years.
TSC: Certainly, Baby Boomers' earnings should continue to increase as they approach retirement. However, a number of research firms have projected a steep draw down in 401(k) money once the Baby Boomers begin to retire in 2010. The anticipated depletion of this large pool of money has many mutual fund companies concerned about attracting and retaining assets in 2010 and beyond.
Froehlich: I think they're dead wrong and it's just hype about all of this money coming out in 2010. Yes, I have seen those forecasts as well. But retired people will not take all of their money out of the markets because life expectancies are at 86 or older. So, we look at these demographic tables and see an opportunity to continue to serve these investors. They are going to need our help to make that money last for 20 years or longer. While it may not be as aggressive a mix of equities, I still don't see that money suddenly being withdrawn and put under the mattress...>> |
