Look who’s fessed up to being irrationally exuberant now.
The Federal Reserve’s surprise half-point cut in the federal funds rate Wednesday handed investors a 299-point gain in the Dow Jones industrial average and a stunning gain of 324 points, or 14.2 percent, in the Nasdaq composite index.
The post-holiday present–which cut the federal funds rate to 6 percent and the discount rate by a quarter-point, to 5.75 percent–was clearly a mea culpa from Alan Greenspan and other Fed policymakers, who had oddly become the last bull in the barn as evidence of a sharp economic slowdown mounted.
And it was welcome news in many quarters, particularly to manufacturers, who had been clamoring for a cut as the sector slowed sharply.
Chicago-based truck and engine manufacturer Navistar Corp. has already laid off workers and seen shipments fall substantially.
“I’m not going to talk about too little,” Chairman and Chief Executive John Horne said. “But I do think it should have been done sooner.”
Just two weeks ago, Fed policymakers met at their scheduled session and left interest rates unchanged, saying some inflation risk persisted.
But the days that followed saw several high-profile bankruptcy filings–including the demise of local retailer Montgomery Ward & Co. after 128 years in business–more layoffs, sliding consumer confidence and further evidence of disappointing holiday sales.
And then, on Tuesday, the bombshell: The National Association of Purchasing Management said its manufacturing output index sank to its lowest level since April 1991, at the close of the last recession.
In the end, it was Federal Reserve policymakers holding onto the once-hot U.S. economic engine, seemingly afraid to let go. The move was the first interest rate cut between meetings since a quarter-point cut in October 1998, during the Asian financial crisis.
“This is one of the most dramatic shifts in Fed policy I can remember,” said Brian Wesbury, chief economist with Griffin, Kubik, Stephens & Thompson, a Chicago investment firm. “Seven weeks ago they said in the statement they were more worried about inflation than recession. The Fed rarely moves in 50 basis point steps, so this is a surprise.”
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Wesbury said last summer that the Fed’s half-point rate increase in May was too severe, and started calling then for a cut. Now the economy is showing the effects from that hike, he said.
The high-profile bankruptcies and the purchasing managers’ report, combined with the fact that commodity prices had started to fall, all pointed to Wednesday’s move ahead of the next regularly scheduled Fed meeting Jan. 30, Wesbury said. “The Fed was looking more and more out of sync with the economic data, and they had to act quickly,” he said.
But any benefits may be longer in coming. The economy has slowed sharply from its superheated growth in the late ’90s, and–one-day stock market rallies aside–lower borrowing costs will work gradually, if they do at all, to head off recession and reignite growth.
“Everybody loves the idea of a rate cut,” said Richard Notebaert, chief executive of Lisle-based tech giant Tellabs, which saw its shares surge 22 percent Wednesday after falling 12 percent in 2000.
But a cut itself, he said, won’t necessarily unleash a flurry of new corporate spending, though it could have a marginal impact through strengthening smaller customers, allowing them to spend more.
“I don’t know [if] we are going to see any impact any time soon,” said Horne, who last year had to cut 15 percent of Navistar’s salaried professional workforce, or 1,100 people. “Lower interest rates should help the general economy, which should help us sell trucks.”
Policymakers left the door open in their statement for another quarter-point cut soon, which economists expect will happen as the economy continues to soften.
“[The economic pain] is not over,” Wesbury said. “When the Fed cuts rates it takes six to nine months to impact the economy, so negative earnings surprises will continue into the summer months. The question is whether the stock market can look past that now that the Fed has come to its senses.”
Other economists and money managers agreed.
Investors’ joy on Wednesday may have been a little premature, they said, because the outlook going forward is anything but clear.
“I think the euphoria we saw today … was a knee-jerk reaction, because let’s face it, the Fed did this because it saw things have deteriorated dramatically,” said Mark Bell, an investment adviser based in Chicago.
Investors would be better off showing cautious optimism, advisers said. “If we see the market skyrocket like last year, that’s not healthy,” said Timothy Schlindwein, a Chicago investment counselor. But if enthusiasm builds slowly, the result could be a decent year in the market, he said.
Around Chicago business circles, corporate leaders cheered the cut. “For a company like ourselves, this will give us a fairly meaningful reduction in our costs because we are a short-term borrower,” said David Storch, chairman and chief executive officer of AAR Corp., a Wood Dale-based aircraft parts and repair company.
“I almost feel like popping out the champagne and celebrating New Year’s again,” said Rick Fleming, chief financial officer for drywall-maker USG Corp. “It’s a positive thing for the economy in general, but the housing markets and the construction markets that we participate in are near-term beneficiaries. As rates come down, mortgages are more plentiful.”
Internet consultants face a murkier crystal ball in trying to figure out if or when the rate cuts will provide them with a bump in business.
Shares of Internet consultants, including Chicago-based MarchFirst Inc., have gone through sharp slumps in recent months as orders slowed and dot-com clients disappeared before paying their bills. John Peschier, MarchFirst’s managing executive of investor relations, said his company’s slowdown in business wasn’t related to the cooling economy, but the rate cut could give it a needed boost.
Although banks participated in Wednesday’s stock rally, investors said the half-point decrease is a mixed blessing for the industry.
On the plus side, corporate customers will be more able to make interest payments, softening what was expected to be a year of heavy commercial loan losses, said Hal Schroeder, portfolio manager for financial services stocks at Carlson Capital, a Dallas-based hedge fund.
On the downside for banks, prime lending rates fall in lockstep with Fed movements, but rates they pay on deposits are slower to follow, which can lead to a margin crunch.
Mortgage refinancings, which often follow Fed rate decreases, might not come as quickly this time because the decrease was already built into the price of existing mortgages, said Moshe Orenbuch, an analyst at Credit Suisse First Boston.
Rick Bechtel, the Chicago area manager for Wells Fargo Home Mortgage, said the decrease was large enough and came early enough to improve the outlook for home buying.
“This should be a great kick start to the traditional spring market in real estate,” Bechtel said.