Recession isn't likely, analysts say

Fed's surprise cuts in 2 interest rates called insurance

Wall Street takes heart

Economic signals of slowing growth have many uneasy

January 04, 2001|By Eileen Ambrose | Eileen Ambrose,SUN STAFF

Despite a slowdown in the economy and the Federal Reserve's surprise move yesterday to cut interest rates, the economy is not in a recession or likely headed for one, economists said.

"The Fed took out an insurance policy against a recession," said Diane Swonk, chief economist with Bank One Corp. in Chicago. "The clear message here is that this Fed is not going to let this expansion go."

The economy is in its 10th year of expansion, the longest in U.S. history. A year and a half ago, when the economy appeared to be overheating, the Fed began a series of six interest-rate boosts to cool the economy down. Since the last increase in May, not only did the economy slow but some feared that the brakes were applied too sharply.

Recent economic indicators lent support to that fear. Unemployment has edged up. Consumer confidence has fallen. All three major stock indexes ended down for the year. And manufacturing activity was reported this week to be at its lowest level since 1991, the last time the country was in a recession.

Economists and analysts had been waiting for the Federal Open Market Committee, the policy-making arm of the Fed, to meet at the end of this month to find out if rates would be cut.

In an unexpected move yesterday, the Fed announced that it was cutting a key rate, the federal funds rate, from its nine-year high of 6.5 percent to 6 percent. This is the rate banks charge each other for overnight loans and is a key indicator of where interest rates are headed.

The Fed also cut the discount rate - what the Fed charges member banks for loans - by a quarter point to 5.75 percent.

The stock market responded swiftly. The Dow Jones industrial average, a blue-chip index, soared 299.60 points to 10,945.75. The technology-heavy Nas- daq composite index rocketed 324.83 points to 2,616.69.

Before the Fed's action, the economy stood a 40 percent chance this year of slipping into recession, said Sung Won Sohn, chief economist of Wells Fargo & Co. in Minneapolis. Now, Sohn places the chance at 30 percent.

"The Fed must continue to cut interest rates again and again and couple it with an aggressive use of open-mouth policy, telling the world that more cuts are coming," Sohn said. He expects rates will need to be cut at least another half a percentage point between now and the Fed's meeting in March.

"Hopefully, we will be able to stabilize the economy and have a soft landing," Sohn said.

David Resler, chief economist for Nomura Securities in New York, said before the Fed's action yesterday that he believed that the data showed that the slowdown had taken hold, although it had not fallen into a full-fledged recession.

"We certainly were on the edge of one. This may be enough to prevent us from tipping over," Resler said.

Even so, Resler predicts another quarter or so of "substandard growth." For the fourth quarter of last year, Resler expects growth of 1.8 percent. For the first quarter, growth may rise slightly to 1.9 percent, he said.

"I will not rule out the possibility of negative growth in the first quarter," he added.

As a rule of thumb, a recession is defined as two consecutive quarters of a decline in the gross domestic product.

While many economists agree the overall economy is not in a recession, some sectors have slid into one.

Manufacturing, including telecommunications equipment, semi-conductors, chip-making equipment, autos, appliances, furniture and other big-ticket items, has been in a recession for the past several months, Sohn said. "We simply built to overcapacity and so demand simply could not keep up," he said.

Agriculture has been in a four-year recession, hurt by a strong dollar and good weather in other parts of the world that reduced U.S. exports, Sohn said. "Today, 40 percent of farm income comes from Uncle Sam in the form of subsidies," he said.

While economists expect more interest-rate cuts to boost consumer confidence and the financial markets, Swonk said, the economy shows signs of recovery. Oil prices have fallen, mortgage rates are down and mortgage applications and refinancings are up, she said.

And Fed Chairman Alan Greenspan, who served under President George Bush and will continue to lead the Fed under his son, George W. Bush, is not about to give up on the expansion, said Swonk, the Bank One economist.

"He was blamed for one recession under another Bush administration; he's not going to be blamed for another," she said.

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