Bigger boom scares stocks

5.8% GDP growth may portend larger FED rate increase

More signs of inflation

Dow, Nasdaq tumble as U.S. economy exceeds expectations

January 29, 2000|By William Patalon III | William Patalon III,SUN STAFF

The white-hot U.S. economy accelerated in the fourth quarter -- as did signs of inflation -- the government reported yesterday, heightening concerns the Federal Reserve will increase interest rates more than expected and sending stocks into a tailspin.

Edward Hemmelgarn, who helps manage $1 billion for Shaker Investments in Cleveland, said three rate boosts were possible this year. "It's going to be tougher to make money in the stock market," he said.

The gross domestic product, the worth of all goods and services produced in the United States, rose at an annual pace of 5.8 percent during the final quarter of 1999, exceeding estimates of 5.2 percent, and after a third quarter in which GDP grew at an annualized rate of 5.7 percent, according to the U.S. Commerce Department.

For all of last year, the economy grew 4 percent, after gains of 4.3 percent in 1998 and 4.5 percent in 1997. The last time the economy expanded 4 percent or more for three consecutive years was in 1976-1978.

But two indicators of inflation closely watched by Federal Reserve Chairman Alan Greenspan also showed building pressure on prices.

The so-called GDP deflator rose 2 percent in the fourth quarter, nearly double the 1.1 percent increase of the third quarter and 33 percent more than the 1.5 percent that analysts had expected.

In addition, a Labor Department report yesterday said that labor costs for businesses also increased more than expected during the fourth quarter, with the payments for health insurance and other benefits showing their biggest gain in seven years.

The employment cost index rose 1.1 percent during the last three months of 1999, after rising 0.8 percent three months earlier. That was more than the 0.9 percent expected by analysts.

Wages and salary costs for all of last year grew 3.5 percent, a drop-off from the 3.7 percent gain of 1998.

Interest rate fears

Yesterday's reports combined with other recent signs that the economy continues to surge, despite three increases in lending rates since June by the Fed, which under Greenspan has adhered to a strong anti-inflationary policy.

As a result, there is an increasing fear that the Federal Reserve's policy-making committee -- headed by Greenspan -- will boost interest rates by as much as half a point, instead of a quarter point, at its two-day meeting next week.

"I would say probably not, but it wouldn't surprise me if he did," said Richard Yamarone, chief economist for Argus Research in New York City. "I think that's what the equity markets are telling us today."

Those fears were played out on Wall Street, where the Dow Jones industrial average plummeted 289.15 points to 10,738.87 while the Nasdaq slid 152.49 -- 3.8 percent -- to 3,887.07. Broader market indexes also fell.

The proportion of those who believe the Fed will tack half a percentage point onto its overnight lending rate next week, taking it to 6 percent, rose to 28 percent yesterday from 20 percent Jan. 7, according to a poll of 23 economists conducted by Bridge News. The poll also found that economists expect that key interest-rate measure to reach 6.25 percent by the end of this year.

"We in economics think backward," said Carl Tannenbaum, chief economist at LaSalle Bank/ABN AMRO North America in Chicago. "We're often said to be able to find a dark cloud behind every silver lining. You can see that by the way the market is reacting."

Mark Zandi, chief economist for RFA Dismal Sciences in West Chester, Pa., said that "the economy is booming, and is on the precipice of overheating."

Record streak

As of Tuesday, the U.S. economy will have grown 107 straight months, the longest streak in history, eclipsing the 106 months of growth from February 1961 to December 1969 -- a stretch aided greatly by the arms production for the Vietnam War, according to the National Bureau of Economic Research, a nonprofit research group.

Leading the charge in the recent economic advance has been consumer spending, which rose 5.3 percent, the largest gain in 15 years. Consumer spending typically accounts for about two-thirds of economic output; however, economists have lately argued that it's been even more.

`Wealth effect' kicks in

That spending has been supercharged partly by the "wealth effect," the willingness -- and ability -- of consumers to spend more than normal given their salaries because their stocks, mutual funds and homes have risen so much in value. The stock market alone has significantly boosted the net worth of many consumers: The Dow was up 25 percent last year, while the technology-heavy Nasdaq soared 86 percent.

The booming economy has also created a labor shortage that has enabled many workers to substantially boost their living standard, either by jumping to different jobs or extracting large raises to stay with their employers.

The labor shortage, whose hallmark has been the draining of the pool of available workers, is potentially highly inflationary, and has been noted often by Greenspan as a cause for worry -- particularly with the nation's unemployment rate sitting at a 30-year low of 4.1 percent.

While yesterday's slide in stock prices shows the fear investors have of higher interest rates, at least one economist says tighter credit and a less-frenetic pace of economic growth could allow U.S. consumers to enjoy the good times for an even longer stretch than if the central bank just stood on the sidelines.

"People complain that the Fed takes the punch bowl away just as the party really gets going," said LaSalle Bank's Tannenbaum. "But I think the real goal is that they want the party to last as long as possible, and to avoid a hangover."

Wire reports contributed to this article.

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