Investors look to Greenspan for help with rate reductions

Martin Crutsinger

Monday, Aug. 12, 2002 | 9:48 a.m.

WASHINGTON -- Could Federal Reserve Chairman Alan Greenspan and his colleagues be getting ready to rescue the bruised economy and battered stock market by cutting interest rates?

Just the mere possibility that Fed policy-makers might reduce already low interest rates at their meeting Tuesday was enough to boost stock prices last week.

After three straight days of triple-digit gains in the Dow, all major stock indexes ended the week higher for the first time in three months. It was a rare sight for a market that has seen $7 trillion of wealth evaporate since the spring of 2000.

The view among many investors is that the central bank increasingly is worried that the stock market's travails, including a summer swoon triggered by corporate accounting scandals, could derail the fledgling economic recovery.

The Fed's solution for an economy in danger of toppling into another recession -- the feared double-dip -- would be to reduce a key interest rate, the federal funds rate.

Lowering the interest banks charge each other would reward consumers and businesses with cheaper borrowing costs in hopes of stimulating demand.

"We've gone from euphoric, irrational exuberance in the markets to irrational despair," said David Jones, chief economist at Aubrey Lanston & Co. in New York. "Greenspan could rationalize that cutting rates now would be like taking out an insurance policy for the economy."

This view holds that the Fed policy-makers would be inclined to lower interest rates now for fear that keeping rates steady would dash investors' hopes and send Wall Street into an even bigger dive.

Morgan Stanley economists Richard Berner and David Greenlaw told investors Friday they were looking for a half-point rate cut.

Many other Fed-watchers say the chance of a cut is remote. After 11 cuts in 2001, the central bank has been content to leave rates unchanged this year, believing them low enough to guarantee an economic recovery.

Deciding now to push the federal funds rate down from a 40-year low of 1.75 percent could be misinterpreted as a sign of panic by the Fed, these analysts believe.

"For the Fed to suddenly start cutting rates would send the wrong signal and that could end up doing more damage than good for the economy," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.

Their argument is that interest rates for consumers and businesses are so low now that further cuts would generate little extra economic activity. For example, the nationwide average for 30-year mortgage rates is at a 32-year low of 6.31 percent.

Many analysts believe the most likely outcome Tuesday is a middle course: The Fed leaves interest rates along but changes the wording of the announcement to signal the possibility of future cuts.

Since its March meeting, the Fed has issued a neutral directive, which indicates the bank sees economic risks as equally balanced between inflation and possible weak growth.

The Fed could have the directive say the greater risk looking ahead is economic weakness, raising the possibility of later rate cuts.

"I think the most likely outcome for Tuesday's meeting is that they will change the directive back to economic weakness and then if nothing changes by September, they will go ahead and cut rates," said David Wyss, chief economist at Standard & Poor's in New York.

The Fed's next meeting after Tuesday is Sept. 24.

While the stock market troubles have caused private forecasters to trim their expectations for the second half of this year, many believe the economy still will grow by about 3 percent, a significant increase from the 1.1 percent rate in the April-June quarter.

If the economy shows signs of stabilizing and stock prices stop falling, then the Fed may remain on the sidelines all year, these analysts believe.

"Our base case is that the Fed remains on hold until the March 2003 meeting when we expect a new tightening cycle to begin," Merrill Lynch economist Stan Shipley said.