Should the Fed Cut Again?

By THOMAS S. MULLIGAN

Nov. 13, 1998 12 AM PT

“Cut, cut, cut! No ifs, ands or buts.”

The author of that couplet, Robert Brusca, chief economist for Nikko Securities in New York, says the continuing fear and uncertainty about the global economy’s future make it incumbent on the Federal Reserve Board to keep pushing interest rates downward.

Generally speaking, proponents of additional rate cuts say that if the Fed thought it made sense to cut in late September and mid-October to combat disorder and worry in global markets, it should keep at it until the job is done.

Yes, Fed Chairman Alan Greenspan acknowledged in a speech last week that investors’ extreme aversion to risk--particularly abroad--had abated somewhat in recent weeks from the panic levels of early October. But the overall thrust of his speech was that there is still a danger that the panic could return.

“Remember why you did it in the first place and let’s finish the job,” Diane C. Swonk, deputy chief economist at Bank One in Chicago, urged the Fed.

“Make sure you’ve really shored up investor confidence before you stop easing,” she said.

Swonk holds this view despite being quite bullish on the U.S. economic outlook.

The Fed should “keep the liquidity spout open for now,” even if it risks having to reverse course a bit next year, Swonk said, adding, “It’s worth risking overstimulation given how fragile the global economy is now.”

Bill Quan, senior economist with Aubrey G. Lanston & Co. in New York, noted that yields on commercial paper--corporate IOUs that generally mature in three to six months--have not fallen since the Fed’s surprise second rate cut Oct. 15. Among financial services firms, commercial-paper yields have actually risen.

That tells Quan, a former trader in such securities, that there remains substantial doubt about the credit-worthiness of corporate America in general, and widespread fear that banks in particular may get hit with significant loan losses in 1999--potentially setting off a new credit crunch in the economy.

Those are the worries that Greenspan cited in his Oct. 8 speech, and to the extent that they are still afoot, the Fed should keep easing rates, Quan said.

Brusca doesn’t share Swonk’s optimism about the U.S. economy, and that makes him all the more certain that more rate cuts are needed.

Despite recent signs of strength in auto sales, for example, the United States is “leaking income overseas like the victim in a cheap horror movie,” Brusca said.

Not only is the export picture bad and getting worse, but the manufacturing sector is “beleaguered”--it lost 52,000 jobs last month--and even the housing market is cooling, he said.

What’s more, U.S. corporate profits are weaker than is generally recognized, other rate cut proponents say. If investors suddenly conclude again that the stock market is overvalued and stampede out of equities, there could be a further erosion of consumer confidence that could translate into a steep cutback in spending.

And consumer spending, which accounts for two-thirds of total economic activity, has been the main engine of the resilient U.S. economy.

“If you’re the Fed, it’s not a good time to squash consumer hopes, with the Christmas season coming,” said Stephen Slifer, economist at brokerage Lehman Bros.

Opponents of further rate cuts say the Fed should resist the temptation to stray beyond its stated mission of keeping U.S. inflation in check and regulating the financial system. Global concerns should be secondary at best.

Swonk rejects such thinking as narrow-minded.

“In a rapidly changing and fragile global economic system, the Fed has got to step out of the box” and take a leadership role, she said.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

U.S. Interest Rates Remain High . . .

The Fed’s benchmark short-term interest rate, the federal funds rate, has been trimmed at 5% from 5.5% since Sept. 29, but remains at the high end of major central bank benchmark rates.

Britain: 6.75%

Canada: 5.5%

U.S.: 5.0%

Australia: 5.0%

Italy: 4.0%

Spain: 3.5%

France: 3.3%

Germany: 3.3%

Japan: 0.5%

. . . but Rebounding Stocks Show Fear Has Subsided

U.S. and foreign stocks resurged since early October after the late-summer plunge. Weekly closes and latest for the Dow Jones industrial average:

May 1: 9,147.07