Rate cut by Fed may not kill bear

Expected drop of half-point thought unlikely to spur rally

March 20, 2001|By William Patalon III | William Patalon III,SUN STAFF

Despite ebbing consumer confidence, a sputtering economy and a savage bear stock market, analysts say it is highly unlikely that Federal Reserve policy-makers will cut short-term interest rates today by the three-quarters of a point most say is needed to immediately reverse the recent slide in stocks.

Instead, the policy-making Federal Open Market Committee is expected to announce a half-point reduction in short-term interest rates. And that decree could easily touch off another downdraft in stocks if not accompanied by a carefully worded statement that underscores the Fed's resolve to cut rates again soon.

"The Fed's going to have a fascinating meeting [today]," said economist Joel Naroff, head of Naroff Economic Advisors in Holland, Pa. "I wish I could be a fly on the wall to hear what's being said."

It's not just the timing that makes this meeting so potentially fascinating - coming as it does with the U.S. economy seemingly at a crossroads - it's the philosophical stance that will result.

Under Federal Reserve Chairman Alan Greenspan, the Fed has repeatedly said its job is to help manage the economy, and not stock prices. But with technology stocks down by more than half from their year-ago high, and blue-chip shares now feeling some pain, the central bank is under increasing pressure to do just that: pump up the ailing stock market with a single, drastic rate cut of three-quarters of a point.

A survey of 39 analysts conducted by Bloomberg News found that 38 percent - a significant portion - expect a rate reduction of 0.75 percentage points in the benchmark overnight lending rate, now 5.5 percent. The other 62 percent expect a half-point cut, meaning that no one surveyed expects the Fed to stand pat, making no move at all.

The Fed cannot ignore these expectations: Anything short of a half-point reduction, along with a statement that signals a strong willingness to revisit the interest-rate question no later than the next FOMC meeting - set for May 15 - could prompt another sell-off in stocks, analysts say.

"We're thinking it's going to be 50 basis points [Wall Street parlance for half a percentage point]," said Jonathan P. Murray, a first vice president with Legg Mason Inc. "But a lot of people on the Street are expecting 75 [three-quarters of a point]. That could cause a sell-off on the news, unless, if they do 50, they couple that with language that they expect to do another [half-point] in May."

With this pressure mounting, the Fed finds itself in a quandary. After boosting interest rates six times between June 1999 and May 2000, the Fed in January acknowledged the severity of the economic slowdown and reduced short-term rates twice for a total of one percentage point - the first time a Greenspan-led central bank cut rates by a full point in one month.

But the continued nose-dive in the technology-dominated Nasdaq - coupled with a decline in the more sedate Standard & Poor's 500 index that has officially reached the bear-market threshold of at least 20 percent from its high - is behind the call for the larger rate reduction. But not everyone agrees the underlying economy needs such a boost. Economic growth is "decently positive, and the Fed is focused on the real economy," said David M. Jones, chief economist at Aubrey G. Lanston & Co. in New York. "The last thing a central banker wants is to be perceived as someone bailing out the stock market."

In the "real" economy, unemployment remains low, and there haven't been the rampant layoffs that historically accompany a deep recession. Home sales are still strong and domestic steel production has been on the rebound since January, when it touched its low for the decade.

Many economists are predicting an economic rebound by the year's second half.

But even the Fed says the economy is sending out contradictory signals about its health.

"There are clearly some signs that might suggest strengthening and some signs that suggest the risks are still to the downside," Fed Vice Chairman Roger W. Ferguson Jr. said last week in Rome.

Unfortunately, in an economy that derives two-thirds of its power from consumer spending, consumer confidence is at its lowest ebb in five years - chiefly because Americans have watched the value of their savings and retirement accounts decline in concert with the drop in stock prices. That's left them feeling less confident and less wealthy, and appears to have crimped spending.

Curing all these ills may demand a rebound in share prices - which some experts say now sit far beneath their true value.

Stocks moved higher yesterday ahead of the meeting. The Dow Jones industrial average climbed 135.70 points, or 1.38 percent, to close at 9,959.11, while the Nasdaq composite index increased 60.27 points, or 3.2 percent, to finish at 1,951.18.

Bloomberg News contributed to this article.

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