Fed Trims Rates in Bold Move to Avoid Recession
Federal Reserve policymakers put on a dazzling display of economic showmanship Wednesday, setting off a buying frenzy in the stock and bond markets by slicing their benchmark interest rate half a point to 4.5% only a week after signaling that no immediate cut was in the offing.
It was the fourth half-point cut of the year and the strongest signal yet that the central bank has no intention of letting the sputtering U.S. economy slip into recession.
The decision dumbfounded investors, who had concluded that the Fed would not act until its next regular meeting May 15, and triggered sharp gains in the stock markets.
The deeply depressed Nasdaq composite index jumped 156.22 points, or 8.1%, its fourth-largest gain in three decades.
The index was up 5% even before the Fed announcement on news that chip giant Intel expected sales to improve.
The Dow Jones industrial average and the Standard & Poor’s 500 index each rose 3.9%, and yields on shorter-term U.S. Treasury securities plummeted.
In its second between-meetings rate cut of 2001, the Fed’s Open Market Committee voted during an 8:30 a.m. conference call to cut the so-called federal funds rate from 5% to 4.5%.
The rate, now at a six-year low, is important because interest charges--for everything from credit cards to industrial loans--are based on it. By late Wednesday, major financial firms such as Bank of America Corp. and J.P. Morgan Chase & Co. had reacted by cutting their prime lending rates half a point to 7.5%
The Fed explained its dramatic move in a statement saying that a combination of stumbling profits and shriveling investment, together with the danger of a spending cutback by stock-shocked consumers and slower growth abroad, “threatens to keep the pace of economic activity unacceptably weak.”
But the very unexpectedness of the cut provoked widespread speculation that something else was also at work. Analysts’ theories fell into three broad categories.
The first was that central bank policymakers have known for some time they were going to have to cut rates further and decided that they could get the biggest bang for the buck by acting when it was least expected.
“They certainly wanted the element of surprise, and they got it,” said Martin J. Mauro, an economist with Merrill Lynch & Co. in New York. “It gave them a bigger market reaction.”
Wednesday’s cut also may have been designed to address lingering criticism that the Fed has done too little too late to keep the economy from sinking.
“It gets them out in front of events,” Mauro said.
But this explanation suggests that senior Fed officials such as William Poole, Federal Reserve Bank of St. Louis president, intentionally misled the country in recent public comments. Poole told reporters just last week that, while there are times when the policymakers should cut rates between their regularly scheduled meetings, “this is not one of them.”
The second category of explanation is that Fed officials have spotted a danger to the economy that is not yet fully appreciated by investors and the public. Among candidates: a burgeoning energy crisis such as that now afflicting California.
“One of the things that really scares the Fed is that soaring gasoline and natural gas prices and rolling blackouts this summer will turn slow growth into recession,” said Mark P. Vitner, an economist with First Union Corp. in Charlotte, N.C. “They’re trying to get the economy ready.”
The third category, and the one most often voiced by analysts Wednesday, is that Fed Chairman Alan Greenspan has grown increasingly worried about the tumble in corporate profits, which has so far proved immune to the usual medicine of lower interest rates.
“He has to have been impressed with company reports in recent days that show outright declines in earnings and [more] layoffs,” said Carol A. Stone, deputy chief economist with Nomura Securities International Inc.
Analysts said Greenspan fears that firms will do as Cisco Systems, the San Jose Internet-gear maker, did Monday and couple disappointing profit announcements with layoffs, setting off a spiral of falling consumption, further corporate contraction and still more layoffs.
And the Fed chairman is just as worried that companies will continue a cutback in capital spending that began late last year. That trend could bring the economy’s boom in productivity, or output per worker, to a grinding halt.
“Productivity growth has been the magic fairy dust of this expansion,” said Diane C. Swonk, chief economist of Bank One Corp. in Chicago. If the Fed can’t keep it going, the nation will be unable to return to the fast growth of the late 1990s without inflation, she said.
“What the Fed is concerned about is the composition of growth,” Swonk said. “They’re less worried about consumption than [productivity-enhancing] capital spending. That’s what they want to get back.”
The Fed’s own explanation appeared to lend credence to this view.
The central bank has changed the focus of its concern during the year. It started by warning about a generalized decline in consumption and production, then shifted to worrying about outsize business inventories, sagging consumer confidence and the effect of the stock market tumble on Americans’ readiness to continue buying.
But Wednesday, the Fed trained its attention on business profits and investment.
“The persistent erosion in current and expected profitability . . . seems poised to dampen capital spending going forward,” the central bank said in its statement.
“The business sector emphasis in the statement is the big surprise of the day,” said veteran Fed watcher David M. Jones, chairman and chief economist of Aubrey G. Lanston & Co. in New York.
“I’m a little concerned about whether this is really needed,” said Charles I. Plosser, co-chairman of the Shadow Open Market Committee, a widely respected group of economists and financial industry experts who monitor central bank decisions.
“I’m a little concerned the Fed is trying to over-manage the economy and play to the stock market.”
Plosser and others warned that interest rate cuts are blunt instruments that do not discriminate between investment and consumption. They said the latest rate reduction is unlikely to do much about the investment slowdown.
Analysts and business executives in California made similar points.
Troubles in the state’s high-tech industries, particularly in the Bay Area, are largely the result of corporate customers’ reducing their capital spending after several years of major investment.
“There’s excess inventory there, and lower interest rates have only a small effect on that,” said Kenneth T. Rosen, a UC Berkeley economist.
Business owners say they are reluctant to take on new debt, even at lower interest rates, at a time when orders are softening.
Kenny Yee, for example, said he has scaled back plans to expand his Los Angeles noodle plant and invest $1 million in new packaging equipment. He acknowledges that a half-point interest rate reduction would save him thousands in borrowing costs. But it’s not enough to tempt him when the economic outlook is so uncertain.
“I care more about the orders on my desk,” said Yee, president of Wing Hing Noodle Co. “We’re going to be cautious.”
Nationally, growth slowed to a 1% annual pace in the final three months of last year, its slowest rate in more than half a decade. Greenspan has said he thinks the economy maintained that anemic pace during the first three months of this year, despite three half-point cuts in the federal funds rate before Wednesday. The funds rate was last at 4.5% in August 1994.
In addition to the funds rate, the Fed’s Board of Governors also voted to cut the so-called discount rate, the rate the Fed itself charges banks for loans, to 4% from 4.5%. That move is largely symbolic, since few institutions choose to borrow directly from the Fed.
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Times staff writers Stuart Silverstein and Marla Dickerson contributed to this report from Los Angeles.
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The Fed Cuts Rates . . .
The Federal Reserve made a surprise cut in its benchmark short-term interest rate Wednesday, trimming it to the lowest level since 1994.
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. . . and Stocks Soar
The Fed’s move sent stocks zooming, lifting the Dow Jones industrial average 3.9%.
