Fed is expected to make another cut Panel will cut rates at Nov., Dec. meetings, economists predict

Interest rates

October 17, 1998|By Robert Little | Robert Little,SUN STAFF

The Federal Reserve's surprise interest rate cut had economists buzzing yesterday, wondering just how worried Fed Chairman Alan Greenspan is that the U.S. economy is headed for a recession.

On two points, however, nearly everyone agreed: He did the right thing, and he's going to do it again soon.

Yesterday Wall Street reacted with continued glee to Thursday's unexpected cut in two key Fed interest rates.

Riding Thursday's 330-point increase, the Dow Jones industrial average closed an additional 117.40 points higher yesterday, closing out the largest one-week gain in history and showing further confidence in Greenspan's move, analysts said.

But amid that confidence came signs yesterday that the economy needs more than one dose of the Federal Reserve's medicine.

Production in U.S. factories declined 0.3 percent in September, evidence that job and wage cuts could be in the works. Employment is flat, and retail sales are slow for this time of year, economists said, all typical warnings that the economy needs repairs.

The interest rate cut surprised the world's financial markets, but some economists suggested yesterday that the cut was part of a plan by Greenspan to slowly tell the market that a recession is looming but that he's ready to head it off.

What all are wondering, they said, is how bad Greenspan thinks things will get.

"The conspiracy theory, that the Fed knows something we don't? I don't believe that. I don't think people should be spooked," said Ira Silver, chief economist for J. C. Penney Co. Inc. in Plano, Texas. "But we are getting some negative signs."

Mark Vitner, an economist for First Union Corp. in Charlotte, N.C., said, "What they've done is give the economy a flu shot. And when it shows signs of getting sicker, they'll give it a booster."

The Federal Reserve cut two key interest rates one-quarter of a percentage point each Thursday. They are the federal funds rate, which banks charge each other for overnight loans, and the discount rate, which the Fed charges on its loans to commercial banks. Official U.S. interest rates are now the lowest in four years.

The Fed acted out of concern that growing caution by lenders and mounting financial turmoil overseas could hurt the world's largest economy. Cuts in interest rates can stimulate the economy and restore investor confidence.

Some of the country's largest banks quickly moved to lower interest rates, cutting their prime lending rates to 8 percent from 8.25 percent.

Some observers suggested that the Federal Reserve acted in somewhat of a panic because banks were showing an increasing reluctance to underwrite large debt offerings, evidence that spending could tighten everywhere. When the Fed similarly shaved one-quarter of a point off the federal funds rate Sept. 29, many were concerned that it wasn't enough.

"I think he realizes he should have eased rates [half a percentage point]) to begin with," said Chris Chmura, chief economist for Crestar Bank in Richmond, Va. "It seems more certain now the economy will slow, and what they did acknowledged that."

Not everyone agreed that the Federal Reserve is worried about the economy.

"The Fed is telling the investors and the consumers and the businesses in the United States and the rest of the world that they're going to do everything they can to ensure that this economy won't slide into a recession," said J. Patrick Bradley, director of economic and investment research for Mercantile-Safe Deposit & Trust Co. in Baltimore.

"But this isn't alarming, it's kind of Greenspan-as-gradualist," he said.

L Not alarming, but not enough either, Bradley and others say.

As surprising as Thursday's rate cut was -- it came unannounced and on a day when the Federal Open Market Committee wasn't meeting -- observers are almost certain the committee will make further cuts. It meets Nov. 17 and Dec. 22, and most economists asked yesterday expect further cuts at each meeting.

The goal, most agree, will be to reverse the "inverted yield curve" that has short-term rates such as the federal funds rate higher than long-term ones.

That indicates that investors are concerned about the near term and are demanding a higher return for the risk they believe they are taking. Inverted yield curves are a sign of a sick economy.

Not cutting interest rates would send a message that investing in the U.S. economy is risky, which isn't the message Greenspan wants to send if he's concerned that the economy could deteriorate.

"Right now the problems seem to be contained on Wall Street; they haven't extended to Main Street," said Vitner.

Pub Date: 10/17/98

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