Fed Delivers Rate Cut With a Hint of More to Come

The Federal Reserve cut a key short-term interest rate half a percentage point to 5% on Tuesday in a drive to keep economic growth--but not necessarily the stock market--from falling further.

Fed officials coupled announcement of the rate cut, the third half-point reduction of the year, with a statement intended to reassure the public that they would do anything necessary to revive growth, which has slipped from more than 4% last year to nearly zero.

Among other things, officials promised to “monitor developments closely”--a code phrase that analysts said meant the central bank could cut rates again before the next meeting of its policymaking Federal Open Market Committee in mid-May.

“The statement left the door wide open for future cuts. In fact, it made them certain,” said Nicholas S. Perna, chief economist of Connecticut-based Perna Associates.

But Fed Chairman Alan Greenspan and his colleagues pointedly resisted a drumbeat of demands that they rescue the stock market from its latest troubles by slashing rates three-quarters of a point or more. In doing so, they effectively bet that the economy could repair itself even with stock prices far off their historic highs of only a year ago.

“The Fed is saying it cares about the economy, not the stock market,” said David M. Blitzer, chief investment strategist with the financial information firm of Standard & Poor’s in New York. “The recent market losses may hurt, but all they did was erase a year and a half or two of gains.”

Investors registered their displeasure with the Fed’s action by dumping stocks and driving down already battered market indexes, although not as far as some Wall Street veterans had warned.

The Nasdaq composite index, widely considered a proxy for the nation’s high-technology sector, fell 93.74 points, or 4.8%, to 1,857.44, its lowest level since Nov. 13, 1998. The Dow Jones industrial average dropped 238.35 points, or 2.4%. to 9,720.76.

Beyond Wall Street, the central bank decision elicited a respectful, if tepid, response.

Jerry Jasinowski, president of the National Assn. of Manufacturers, whose members are bearing the brunt of the slowdown, called the rate cut “a very helpful step toward bringing the economy out of troubled waters.” Senate Finance Committee Chairman Charles E. Grassley (R-Iowa) said the move was in the right direction, but not large enough.

The Fed cut the so-called federal funds rate, the interest banks charge each other for short-term loans, from 5.5% to 5%, a 19-month low. It also reduced the largely symbolic discount rate, the interest the Fed itself charges for short-term loans, by half a point.

Commercial banks are expected to pass on some or all of the rate reductions to their borrowers, a move that could help revive the economy. Shortly after the Fed announced its rate cuts, major New York banks reduced their prime lending rate to 8% from 8.5%.

In explaining their action, central bank policymakers cited a slump in U.S. manufacturing and a buildup of excess factory capacity. They suggested that the problem could combine with others, such as global economic weakness, to extend the slowdown well beyond what they had expected.

“The possibility that this excess could continue for some time and the potential for weakness in global economic conditions suggest substantial risks that demand and production could remain soft,” they said in the statement.

Policymakers made glancing mention of the recent stock slump in their statement, saying that “recent pressures on profit margins are restraining investment spending and, through decline in equity wealth, consumption.”

But whether the Fed should accommodate Wall Street with steeper rate cuts provided the day’s central drama and illustrated the tricky economic terrain on which the central bank is operating.

The Fed’s predicament is this: The real, goods-producing and services-providing economy does not seem to be in as rough shape as experts thought even a couple of months ago, but the stock market is behaving as though economic disaster were just around the corner.

True, growth has slowed drastically, but few analysts believe the economy has begun to shrink. “People have been throwing around the word ‘recession’ irresponsibly,” said Maureen F. Allyn, chief economist with Zurich Scudder Investments in New York.

Americans’ confidence about their economic prospects has plunged from last year’s cocky highs. But one widely followed confidence index showed last week that consumers’ moods have improved somewhat. And in any case, Americans have continued making the purchases that require the greatest confidence--homes and cars--in surprisingly large numbers.

“If you just looked at the real economy, you’d think that things are slumping, but they’re not falling out of bed,” said Mickey D. Levy, chief economist with Banc of America Securities in New York.

But then there is the stock market. In the 49 days since the Fed’s last rate cut Jan. 31, the Dow Jones industrial average has lost more than 1,000 points. Last week alone it slid 7.7%, its worst weekly performance since October 1989. Nasdaq, which has dropped for seven weeks in a row, has lost 25% of its value just since Jan. 1 and almost two-thirds from its high of last year.

Economists have long worried that a tumbling market could produce a so-called negative wealth effect, a contraction in the value of Americans’ financial assets big enough to cause people to sharply curtail purchases. With consumers buying almost 70% of the nation’s annual output of goods and services, such a pullback could prove economically disastrous.

The stock market rout has indeed trimmed Americans’ wealth. Even without adjustment for inflation, household net worth fell by 2% last year, its first such fall since the government began keeping records in the 1940s. But at least so far the decline has had comparatively little effect on consumption.

However, according to analysts, another trend that could prove equally damaging to the economy has recently picked up speed: cutbacks in corporate spending and investment designed to defend companies’ sagging stock prices.

Firms have begun announcing layoffs and cutbacks that analysts say are often far more draconian than immediate economic conditions warrant. Financial giant Citigroup, for example, recently signaled that it planned to trim its budget by as much as $2 billion this year alone. Analysts say that at least in part, the move reflects Citigroup Chairman Sanford I. Weill’s desire to convince investors the company deserves a higher share price.

“The real economy statistics allow you to spin a tale about how we’re close to the soft landing the Fed has been promising us,” said Robert J. Barbera, chief economist with Hoenig & Co., a New York-area brokerage house. “But . . . the stock market is screaming, ‘We’re in trouble.’ And it can make its own predictions come true.”

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Ups and Downs

The Fed’s key short-term interest rate since 1989:

Tuesday: 5%

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REACTION TO CUT

History says financial markets react well to Fed rate cuts, but it probably won’t happen overnight. C1 . . . More on the impact of the Fed decision, C1, C4