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Fed acts to head off recession
By HELEN HUNTLEY © St. Petersburg Times, published January 4, 2001 The Federal Reserve Board cut short-term interest rates half a percentage point Wednesday in an attempt to revive the sagging economy, the first such cut in two years. Investors reacted with glee, sending stocks soaring and the Nasdaq to its best day ever. Although a rate cut was widely anticipated, the Fed acted sooner and more decisively than most had expected. The cut followed a string of six increases. Lower rates make it easier for consumers to borrow and spend, which Fed officials hope will avert a recession. "This is good news for home buyers, but not necessarily good news for savers" who will collect less in interest, said Greg McBride, a financial analyst for Bankrate.com in North Palm Beach. He said rates for mortgages and certificates of deposit already have been declining, tracking the bond market, which anticipated the Fed's move. In the next few months, consumers should see rates dropping for credit cards and for home equity, auto and other variable rate loans, McBride said. It also should become less expensive for businesses to borrow money for expansion. What makes investors especially cheerful is the thought that it could be just the beginning of a series of rate reductions. The Fed cut the Federal Funds Rate, the rate banks charge each other for use of federal funds, by a half point, to 6 percent. It also reduced the less important Discount Rate, the rate at which it lends money to member banks, by a quarter point to 5.75 percent. Still, both rates remain substantially higher than they were two years ago, when they stood at 4.75 and 4.5 percent, before the Fed began raising rates to fend off inflation. "The rate cut is meant to send a powerful psychological signal that the Fed is not going to sit around and let the economy slide into a recession," said Scott Brown, senior economist at Raymond James & Associates in St. Petersburg. But there were also jitters that the high-powered analysts at the Federal Reserve may have been jolted into quick action by their private soundings of an economy in rapid decline. Along with the rate cut, the Fed delivered a sobering message: "These actions were taken in light of further weakening of sales and production and in the context of lower consumer confidence, tight conditions in some segments of financial markets and high energy prices sapping household and business purchasing power." Those reports of weaker conditions and faltering corporate profits have raised fears that the economy is coming in for a hard landing, if not an outright recession, after nearly a decade of economic expansion. Raymond James economist Brown said he was surprised by the Fed action because the half-percentage point increase was twice what analysts expected and because it came so quickly. Many analysts thought the Fed would wait to act at its regular meeting Jan. 30-31. Brown said he expected the Fed to wait at least until the monthly employment report that is to be released Friday. "Generally the Fed takes baby steps," he said. The news may be a signal that the employment numbers will be weak, said Bill Sieffert, senior vice president for Northern Trust Bank of Florida in Tampa. But at least in the short run, the decisive action gave investors confidence. The beaten-down Nasdaq Composite Index surged to its biggest-ever point and percentage gains. The index rose 324.83 points, or 14.2 percent, to close at 2,616.69. The Dow Jones Industrial Average rose 299.6 points, or 2.8 percent, to 10,945.75. Investors sold many of last year's big winners, such as pharmaceuticals and utilities, to pour money into technology. It also was a good day for financial stocks, which will benefit from lower rates. But it wasn't just Wednesday's move that investors were cheering; it was the prospect of more rate cuts to come. Many analysts are expecting rates will be down a full percentage point by midyear. Trading on the futures market Wednesday afternoon already priced in another quarter-point rate cut at the regular Fed meeting at the end of the month. The last time the Fed changed rates between regular meetings was in 1998, when it moved to counter financial turmoil stemming from a currency crisis in Asia. It was just last month that the Fed announced it had switched its chief concern from inflation to recession. Aside from the boost in morale the action provides, economic relief will not be immediate. It takes time for the impact of rate cuts to trickle through the economy. Banks look at the federal rates in setting their own rates for lending and borrowing. Some rates, such as the prime rate for the best business customers, are likely to change relatively quickly. But others, such as credit card rates, may be adjusted once a quarter. "Just as it took a year and a half for the economy to begin to slow after the initial interest rate increases, I would likewise expect that the benefits to be derived from a decrease in interest rates won't come tomorrow," said Sieffert at Northern Trust. "It's a longer-term scenario." Some political leaders, including President-elect George W. Bush, are campaigning for a tax cut to further stimulate the economy. Hosting an economic meeting in Austin, Texas, Bush praised the interest rate cut as a "bold move" but called as well for "bold action in the halls of Congress to make sure this economy stays vibrant." In a significant sign that Democrats are under pressure to meet Bush halfway, House Minority Leader Richard Gephardt, D-Mo., said on NBC's Today show Wednesday morning that tax cuts may have to be bigger than his party had been willing to accept previously "because the recession is looming and we've got economic worries out there." - Information from Times wires was used in this report.
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