Stock Losses, Easing Growth Could Forestall Rate Hike

Turbulence in the stock markets, with prices for technology companies declining sharply, is likely to make consumers more cautious and could even make the Federal Reserve think twice about new interest rate hikes, economists said Tuesday.

Despite Tuesday’s late recovery from steep declines, such extreme volatility in both the Nasdaq composite index and the Dow Jones industrial average suggests that many people are reassessing the outlook for stock prices, experts said.

Such an atmosphere could stem the buoyant consumer spending made possible by the “wealth effect” of investors splurging their unprecedented winnings in the stock market.

In fact, consumer confidence has declined for the last two months from a record high in January, according to an index published by the business group Conference Board. On Tuesday, the board’s Index of Leading Indicators, which predicts the economy’s behavior over three to six months, showed its sharpest monthly decline in four years.

The underlying U.S. economy remains very healthy, experts emphasized. The leading indicators and other evidence, such as recent declines in home construction, show the economy slowing from the breakneck pace of late last year.

But slowdown is a relative term. The outlook now is that U.S. output of goods and services will increase by 4%--or more than $300 billion worth--this year. Although lagging the fourth quarter’s robust 7.3% growth, that’s a pace much faster than most experts believed possible only a few years ago.

Yet with consumers throttling back their enthusiasm and investors reappraising their expectations, Fed Chairman Alan Greenspan “is unlikely to further tighten the reins,” said William Rhodes, chief economist of the Williams Capital Group, a New York investment firm.

The Fed has boosted rates five times, from 4.75% to 6%, since mid-1999 in response to Greenspan’s warnings of the threat of inflation and his repeated jawboning aimed at cooling the fervor on Wall Street.

The Fed’s interest-rate setting Open Market Committee doesn’t meet again until May 16, so the Fed chairman has plenty of time to watch the economy’s pace and consumer spending levels.

But where many economists had been predicting that the Fed would raise interest rates as much as half a percentage point in May, now they say that a moderating pace of growth and stock market declines could persuade the Fed to leave short-term rates alone.

As stock prices rose ever higher over the last year, the threat of a market collapse has worried economists because stock ownership has become so widespread among Americans. They fear that a steep falloff would depress consumer spending, thus stalling the engine of the nation’s record economic expansion.

But stock market volatility notwithstanding, many economists still see no immediate threat to continued expansion of the vast U.S. economy. It would take a decline of 20% to 30% in the major market averages to “dent the economy,” said Nariman Behravesh, chief economist of Standard & Poor’s DRI, a Lexington, Mass.-based research firm.

Despite the latest market turmoil, since Jan. 1 the Nasdaq is up 2%, the Dow is down 2.9%, and the Standard & Poor’s 500 index is up 1.7%.

Productivity gains, brought about by industry’s use of the Internet and advanced computer systems, have enabled the economy to grow faster than before without causing inflation, Behravesh said.

Still, technology stocks clearly were overvalued, he added. The current retreat of their prices as measured by the steep decline on Nasdaq in recent weeks reflects only that a slowing economy might prompt industry in general to buy less of the goods and services that technology companies sell.

Not all economists agree about productivity, which means output per unit of labor or investment. To be sure, productivity is rising--but at 2.3% a year, not as fast as some enthusiasts for a “new” economy have claimed, said Daniel J.B. Mitchell of the UCLA Anderson School.

What has really held back inflation is restrained growth in labor costs--average wages rising 3.5% a year, Mitchell said.

But now the labor cost picture may be shifting as low unemployment and a shortage of labor serve to increase workers’ leverage.

Economists note increased union militancy in some industries, pointing to the generous settlement of the recent strike at US Airways. Likewise, janitors in Los Angeles were out on strike Tuesday, demonstrating for a $1-an-hour rise in their $6.80-an-hour pay.

“In a tight labor market, the building owners will pay the $1 if they can’t find anybody else to do the janitorial work,” said economist Rhodes.