Fed is facing key decision this week

It's expected to cut rates again in bid to avoid recession

10-year boom loses steam

Layoffs piling up, companies failing, confidence waning

January 28, 2001|By William Patalon III | William Patalon III,SUN STAFF

Even after a steep and surprising interest-rate reduction this month, Federal Reserve policy-makers approach this week's meeting needing to cut rates further to keep an already worrisome U.S. slowdown from sliding into a recession, economists say.

And even that might not be enough.

Economists disagree over how steeply and how soon rates should be cut, but many experts say the central bank faces its biggest challenge in a decade in its bid to prolong an economic boom that is in its 10th year, the longest expansion in U.S. history.

"If we avoid having a recession, it will be because the Fed acted as if they were afraid we were going to have a recession" and cut rates deeply and aggressively, said Alan Levenson, chief economist for T. Rowe Price Associates Inc. in Baltimore.

In a surprise move Jan. 3, the central bank's policy-making Federal Open Market Committee announced a half-point reduction to 6 percent in the federal funds rate, a benchmark that guides lending rates for business and consumer loans.

Fed Chairman Alan Greenspan's Senate testimony last week suggested that the Fed was likely to cut rates by another half a point when it meets Tuesday and Wednesday.

Slashing interest rates by half a point twice in a month would underscore the central bank's concern over the problems that are threatening to transform the "soft landing" Greenspan desired into a crash landing of a recession, economists and investment experts say.

Among those problems:

A weakening in corporate earnings and an increase in profit warnings.

Overly optimistic investments in new technologies and equipment, particularly in the telecommunications arena.

A downturn in manufacturing and indications that the sector is in recession.

An energy crisis in California that some economists fear could ripple across the nation.

A weakening in retail sales - especially for big-ticket items such as cars and trucks - that could signal a rising hesitance among consumers to spend. That would be especially troublesome because consumer spending accounts for about two-thirds of the nation's economic activity.

There are other bothersome signs. Unemployment has edged up in recent months. Layoffs, some of them extensive, are increasing. Bad business debt is rising. And, though technology stocks have shown signs of life, the market for new stock offerings - where emerging companies often obtain the money they need to grow - remains in a deep freeze.

"The numbers are deteriorating so fast that I wonder if we could be looking at the end of the longest expansion in history," said James Hardesty, head of Hardesty Capital Management in Baltimore. "This is going to be really close as to whether we can avoid having two consecutive quarters of negative [growth in the gross domestic product], which would qualify as a recession."

Not every economist has such a grim view. Joel Naroff, head of Naroff Economic Advisors in Holland, Pa., sees an economy that is healthy overall, even though it has slowed.

"I'm not in the camp that [thinks] we're going to have a recession," Naroff said. "I'm actually a little bit more cautious in my view about how far the Fed has to go." He said he believes the central bank doesn't need to aggressively trim rates.

Wall Street clearly is on the side of more cuts. The Fed's abrupt Jan. 3 reversal, after raising rates six times from June 1999 to May 2000, was enough of a surprise to spark a record one-day jump of 14 percent in the technology-heavy Nasdaq composite index.

The recent Nasdaq upturn, in the face of continued earnings disappointments, was sparked largely by the expectation of a half-point cut now, with more reductions in the months ahead, many say. Any disappointments could cause stocks to tumble.

How much more interest rates must come down is being debated. Many experts say an overall drop in the federal funds rate of 1.75 percentage points from its nine-year 6.5 percent peak set in May - including the half-point cut of Jan. 3 - would suffice, but others have started calling for a steeper reduction.

Hardesty, the Baltimore money manager, thinks rates must come down an additional 2 percentage points. That would bring the federal funds rate to 4 percent.

Even that might not do the trick, said John P. Hussman, portfolio manager of the Hussman Strategic Growth Fund, a new mutual fund in Ellicott City. The most serious problems facing the U.S. economy aren't the kind that rate reductions will resolve, he said.

The reason is that the national economy grew at a clip of better than 4 percent from 1997 through 1999, then raced along at a 5.2 percent annual rate in the first half of last year, before the rate increases got traction. That slowed the economy to a 2.2 percent growth rate in the third quarter and probably slower still in the final three months of last year.

That such a large economy could grow so fast for so long with no inflation stemmed largely from substantial investments in new technology.

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