Fed Move Fails to Cheer Investors
Wall Street isn’t sure how much lower interest rates will go as the Federal Reserve tries to jump-start the economy, but some analysts are drawing one strong conclusion from the central bank’s aggressive cuts so far: Short-term rates are likely to remain at historically low levels for at least the next year.
As recently as two months ago, some experts believed that cheaper credit, and the federal-income tax rebates now arriving in consumers’ mailboxes, together would be enough to stoke a strong rebound in the economy by early 2002--and that the Fed might have to respond by quickly raising interest rates again.
But those expectations have faded, and were further dashed Tuesday by the Fed’s renewed warning about economic weakness.
“We’re in for a lengthy period of low interest rates,” said David Wyss, chief economist at Standard & Poor’s Corp. in New York. “I don’t see the Fed moving rates up until 2003.”
Some economists draw comparisons to 1992-93, when the Fed kept its benchmark short-term rate, the federal funds rate, at 3% for 17 months.
The prospect of a long period of low rates is something of a double-edged sword for the economy.
Of course, low rates carry a host of salutary effects, and they could set the stage for sustained economic growth later this decade.
But savers dependent on interest income could suffer mightily because of rock-bottom rates paid on bank accounts and money market funds. The average seven-day annualized yield on taxable money funds now is 3.25%, according to Imoneynet.com. That yield could fall below 3% soon with the Fed’s latest cut.
What’s more, if rates indeed remain at current levels, or fall further, it would almost certainly mean that any economic recovery is proceeding at a frustratingly slow pace--the charge leveled at the Fed in 1992-93.
Chairman Alan Greenspan and his Fed cohorts brought their key rate down to 3% in September 1992 and kept it there until early 1994.
The economy had officially emerged from recession early in 1991. But the recovery appeared almost imperceptible to many analysts--and to many businesses and consumers--through much of 1992 and into 1993.
Still, economists doubt the Fed this time will keep rates low for as long as it did in the early 1990s.
In addition to the severity of the 1990 recession, and fear of a relapse, there were two specific reasons the Fed kept rates so depressed in 1992-93, said Lou Crandall, chief economist at Wrightson Associates in New York.
For one, policymakers wanted to counteract the dampening effect of the 1990 federal tax increase, he said.
Second, the Fed wanted to help U.S. banks return to financial health after brutal losses tied to real-estate and corporate-takeover loans made in the late-1980s.
By keeping short-term rates low, the Fed allowed banks to borrow at cheap rates, and invest the proceeds in higher-yielding, longer-term Treasury securities. The profit earned on the “spread” between short- and longer-term rates helped the banks rebuild their capital.
This time, the banking system is in far better financial shape, most experts say.
Even so, the economy’s struggle to rebound--and in particular the problems of the corporate sector, and many companies’ reluctance to spend money on new equipment--argue for the Fed to keep rates down until at least next summer, even if signs of economic revival surface, some experts say.
“At this point, we’re looking for many months, probably close to a year, where rates will stay at a lower level,” said Lynn Reaser, chief economist at Banc of America Capital Management in St. Louis.
In the corporate sector, low rates would help profitability by keeping borrowing costs down.
And though savers would be hurt by low rates, consumers who have heavy debt would be helped, analysts note.
And if long-term rates (such as on mortgages) remain low as well, the housing sector--which has played a critical role in propping up the economy--could get a further boost, some say.
