Will the rate cuts save the economy?
Most analysts optmistic but many doubts remain
By Martin Wolk
MSNBC
April 20 — Alan Greenspan is back on his game, but only time will tell whether the Federal Reserve’s fourth rate cut in as many months will result in a meaningful economic rebound by late this year. For now, the central bank chairman is being praised for a masterful stroke of timing, sparking a shift in psychology that could mark a turning point in the battered stock market.
IN THE AFTERMATH of the Fed’s shock half-point rate cut Wednesday, Wall Street analysts were effusive in their acclaim for the 75-year-old chairman. “Hallelujah!” exclaimed Jeff Applegate, chief investment strategist at Lehman Bros.
In a note to clients, Applegate reminded his readers that he was among several analysts who turned bullish months ago, reasoning that historically the stock market has hit bottom and begun rebounding an average of three months after the Fed begins a rate-cutting cycle. “Who would have known that it would have been this precise, as the April 4, 2001, low is three months and one day from the Fed’s first ease back on Jan. 3, 2001?” he wrote.
Such praise came just four weeks after Greenspan was roundly criticized for failing to move more aggressively at the March 20 meeting of the Fed’s Open Market Committee, when the central bank lowered rates a half-point, sending stocks into a three-day tumble.
A RAY OF HOPE
Not everyone is ready to declare that stock prices have bottomed and the bear market is dead, but even economic pessimists agree that the Fed has done a world of good by injecting a ray of hope into the beleaguered financial markets.
“The Fed is providing some powerful stimulus here,” said Bruce Kasman, senior U.S. economist for J.P. Morgan Chase & Co. “It’s still too early to make a judgment that this is a turn.”
Kasman said that for now, the Fed has boosted sentiment throughout the financial markets and made it more likely that European central banks will follow its lead and loosen credit. But he still see significant risks as corporate America struggles through one or two more quarters of extremely weak earnings, posing a risk of more layoffs and slower consumer spending.
“You’ve got to believe the Fed did something here because of the significant downside risks they see emerging,” Kasman said. “I think it still is an open question whether they’re going to succeed in arresting the downturn.”
While Kasman said it will be months before we will know whether labor markets and consumer demand have stabilized, he said he takes no comfort at all from the recent wave of earnings that generally have met or exceeded lowered expectations. Many companies with heavy exposure in telecommunications and the failed dot-com sector have continued to warn of slow growth ahead, including Sun Microsystems, Cisco Systems and Sweden’s wireless giant Ericsson.
In fact, an overhang in technology and telecommunications left over from the spending binge of 1999 and 2000 has become one of the Fed’s biggest concerns and a major unknown to analysts trying to predict the near-term future of the economy. In its statement Wednesday, the Fed noted that manufacturers have worked down inventories, but depressed corporate earnings and uncertainty about the economy have kept a lid on capital spending.
“I think it’s pretty clear there is a pretty substantial glut in technology investment, and it’s going to take some time to work that off,” said Scott Brown, chief economist for Raymond James. “Lower interest rates won’t really do much to help that situation in the short term.”
But the Fed’s move should give corporate executives increased confidence that the economy is less likely to go spiraling downward into recession, and that consumers will continue to but their products, Brown said.
“There are fears that we’re going to end up with a vicious cycle of layoffs, lower consumer spending and lower investment, and it all just feeds on itself,” he said. “The message the Fed sent was that … they’re going to do whatever it takes to keep the economy from going into a recession.”
Kenneth Matheny, senior economist at Macroeconomic Advisers in St. Louis, thinks the Fed may already have done enough in slashing the overnight federal funds rate to 4.5 percent from 6.5 percent less than four months ago.
“We think there is a good case to be made that the economy will — if not come roaring back — by the second half of the year be growing at a trend rate,” he said. “The Fed could sit on the sidelines for a little while and wait to see what the effects will be of the rate cuts they have put in place so far.”
Matheny would not go so far as to predict that the Fed will leave rates unchanged when central bank policy-makers meet again May 15. Market analysts believe it virtually certain the Fed will lower short-term rates by another quarter-point at that meeting, and most believe the Fed will cut rates another half-point.
But Matheny agrees that the oversupply of technology equipment remains the biggest cloud hanging over the economy.
“It may take a couple of quarters or even a few years to work off,” he said. “That would delay the time when the economy could take off in a vigorous, robust fashion. That’s something that’s hard to estimate, and something that we’re struggling with.”
Michael Swanson, an economist with Wells Fargo, noted that the Fed’s rate-cut campaign has restored order to the bond market, where an “inverted” yield curve had indicated that bond investors expected a recession.
“The Federal Reserve’s surprise rate cut was classic monetary policy at work,” he said in a note to clients. “Only the unexpected has the power to make an impact.”
In an interview, Swanson said that by moving now, the central bank could help trigger a change of sentiment by bringing a quick end to a waiting game that may be preventing some corporate executives from moving ahead with spending plans.
“People get to the psychological point where they want one more rate cut to act. … There’s a huge waste in terms of management attention on issues like this. So there’s something to be said for getting to that point (of the final rate cut in the cycle).”
“I think the Fed had pretty good timing,” he said.
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