Markets Force Fed to Make a Big, Risky Rate Cut
Commentary by John M. Berry
Jan. 23 (Bloomberg) -- Federal Reserve officials, responding to the risk that plunging stock markets around the world posed for U.S. economic growth, cut the benchmark interest rate by 75 basis points. The Fed's unexpected action carries its own risk --that investors may be spooked even more by a hint of panic at the central bank.
``This extraordinary action was excessive and smells of fear,'' said economist Willem Buiter, a professor at the London School of Economics and Political Science and a former member of the Bank of England's Monetary Policy Committee.
``It is the clearest example of monetary policy panic football I have witnessed in more than 30 years as a professional economist,'' Buiter said in an Internet posting yesterday. ``Because the action is so disproportionate, it is likely to further unsettle markets.''
Disproportionate or not, many analysts said the cut to 3.5 percent from 4.25 percent may well be followed by another 50 basis-point cut at the end of the Federal Open Market Committee meeting on Jan. 30.
It was the largest reduction in the lending rate since the Fed began using it as its main policy target in 1988 in the wake of the October 1987 stock market crash.
The action occurred even though outside of the financial markets, the recent flow of economic news has been more in line with a period of slow growth than a recession -- whatever the stock market thinks.
``We understand the macro challenges facing the economy and many uncertainties, but we believe this level of pessimism is unwarranted,'' New York-based UBS Securities LLC equity strategist David Bianco wrote in a note yesterday. ``The market is panicked over a substantial and secular drop in earnings power.''
Monday Decision
FOMC members decided to lower the lending rate and the discount rate -- the interest rate charged when banks borrow from a regional Federal Reserve bank -- during a video conference meeting on the evening of Jan. 21.
The statement announcing the actions came yesterday before markets opened and said they were taken because of ``a weakening in the outlook for economic growth and increasing downside risks to growth.''
``While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households,'' the statement said.
The decision had to be risk management with a vengeance, because outside the large continuing decline in stock prices there were no shocking economic developments. Perhaps Fed Chairman Ben S. Bernanke's intention was to get the markets' attention and halt their plunge long enough for a sense of economic reality to sink in.
Unnoticed Threat?
Or maybe Fed officials became aware of some unnoticed threat to the economy.
The broadest recent survey of the U.S. economy was by the 12 Fed district banks released Jan. 16 covering the period from mid-November through December. It found no indication of recession.
Instead, the survey summary said economic growth ``increased modestly, but at a slower pace compared with the previous survey period.'' Only three of the dozen districts described the economy ``as slowing.''
Housing was weak, of course, and construction jobs were falling, according to the survey. On the other hand, the banks ``cited robust demand in several non-financial service industries including health care, hospitality, legal, and insurance.''
All that pointed to slower growth, not a recession.
Unemployment Concern
One set of numbers that concerned Fed officials involved December's labor market: a jump in the unemployment rate to 5 percent from November's 4.7 percent, the very small 18,000 increase in payroll jobs and the rise in initial claims for jobless benefits through the week ended Dec. 22.
Those are disturbing figures, though in the latter case new claims have plummeted to 301,000 in the week ended Jan. 12 from 357,000 in that December week. There's no ready explanation for that decline.
What is known is that in the past, including during the 2001 recession, payrolls didn't begin to fall until weekly claims passed the 390,000 mark, and the country isn't close to that yet.
Meanwhile, industrial production was unchanged in December, neither a sign of strength nor of recession.
And the Reuters/University of Michigan consumer sentiment survey was up this month 5 points on a preliminary basis, to 80.5, from 75.5 last month and 76.1 in November, again hardly a sign of recession.
Will Panic Subside?
The housing market still is a serious problem, and the FOMC statement noted the ``deepening of the housing contraction'' as one reason for yesterday's move. Still, there has been remarkably little spillover from housing to the rest of the economy, and time, not lower rates, is what's needed for housing.
``It's possible that with the amount of stimulus we've seen coming from the Fed, and the talk of a stimulus package, that this ends up being a fly-by'' slowdown in growth, said Jonathan Lewis, a founding principal at Samson Capital Advisors LLC in New York, which manages $3.8 billion.
Whether what Bernanke and his colleagues have done is successful will depend on whether the panic in financial markets subsides.
(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net
Last Updated: January 23, 2008 00:15 EST |
