This Could Take Awhile: Little Has Changed Since the Fed Started Cuts

Six months of rate cuts, and whaddya get? So far, six months older, and deeper in debt.

The Federal Reserve started its series of cuts in the fed funds rate a little more than six months ago, and not much has changed. The stock market averages are still flailing and economic conditions are mixed.

The general mood among investors remains a mix of that eternal optimism to envision good things coming around the corner, and to shake their fists at the Federal Reserve for reacting too slowly, or not simply giving out C-notes to anybody walking around on the Street. Of course, this is when one would take care to remember that it takes more than six months for interest rate cuts to work their way into the economy. And when the Fed first cut rates Jan. 3, in a surprise move that dropped the funds rate to 6% from 6.5%, its monetary policy was arguably still tight and choking off economic growth.

Now, it's hard to argue that at 3.75% the fed funds rate is restricting the economy. It's likely that the Fed is nearly finished with its series of cuts. It's even possible that they are done, opting not to cut rates at the August meeting.

Now, About Those Rate Cuts...
	1/2/2001 (The day before the first easing)	7/13/2001	Change
Target Fed funds rate	6.50%	3.75%	-(2.75)
Dow Industrials	10,646.15	10,539.06	(1%)
S&P 500	1283.27	1215.68	(5.3%)
Nasdaq Composite	2291.86	1972.01	(9%)
10-year Treasury	4.917%	5.225%	0.308
Yr-over-yr CPI	3.39%	3.62%	0.23
Yr-over-yr core CPI	2.58%	2.54%	0.04
Yr-over-yr PPI	1.90%	3.20%	1.30
GDP Deflator	1.60%	2.00%	0.40
Real GDP (yr-over-yr % change)	3.40%	2.70%	(0.7)
Unemployment Rate	4.0%	4.5%	0.5
Avg. Hourly Earnings (year-over-year % change)	4.32%	4.31%	(0.01)
NAPM Index	41.20	44.70	3.5
Industrial Production	147.69	143.10	(4.59)
Housing Starts	1.58 million	1.62 million	2.5%
Home Sales	1,001,000	928,000	(7.3%)
New Building Permits	1.51 million	1.62 million	(6%)
Retail sales (yr-over-yr % change)	1.2%	4.4%	3.2%
Consumer Confidence	128.60	117.90	(10.7)
Leading Economic Indicators	108.50	109.30	0.80
Gold	$268.40	$267.10	($1.30)
Oil	$27.21	$26.59	($0.62)
Bridge/CRB Index	224.99	207.31	(17.68)
Sources: Commerce, Labor Depts., Federal Reserve, Reuters

"It takes some time for those interest savings to make a difference for companies and consumers," said Mark Vitner, capital markets economist at First Union. "We should begin to see improving consumer fundamentals in the second half of the year, as well as slightly better corporate profits."

Looking over the economy, there are a few bright signs that have emerged in the last couple of months. Most of the strength in the economy remains in the areas that have been strong already: consumer spending and the housing market. Consumers maintained a steady rate of spending through the second quarter and housing sales have also proceeded at a brisk pace, if not with the vigor of 2000. Automobile sales are still strong, though orders of other durable goods have fallen off significantly.

"We think housing will soften modestly, but nothing like you would have seen in past cycles," said Joshua Shapiro, chief U.S. economist at MFR. "You can say the same thing about autos. These are the two areas that tend (in downturns) to collapse and bounce back. Well, they didn't collapse, but there was no bounce either."

Manufacturing remains in the doldrums, though the National Association of Purchasing Management's purchasing managers index showed an upswing in June, pushing that index to its best reading since the end of the year, an indication that the manufacturing sector is perhaps starting to respond to rate cuts. More likely it signals companies have completed the majority of their cost-cutting efforts; the rate of job loss and inventory reduction has slowed in the last two months.

Long-term interest rates are a concern, however. The 10-year Treasury note's yield is at 5.29% currently, or three-eighths of a percentage point higher than where it was when the Fed started cutting interest rates. Companies and individuals benefit from lower interest rates; it makes it easier to borrow money. While bank loan rates have dropped in response to the aggressive Fed rate cuts, long-term market rates, which are used to calculate interest rates on mortgages, bond sales and car loans, are higher, which could inhibit borrowing.

Overall, economists expect growth will remain sluggish in the third quarter, expecting little in the way of business investment and perhaps a slight pullback by consumers as interest rates rise. Second-quarter growth should end up around 1%, and the third quarter won't be much better.

The fourth quarter could show some improvement in the business end, but some are concerned the consumer will spend less, which would slow growth further. Of course, as one arm of the government (the Fed) stops its prodding of the economy, another steps up to the plate: The forthcoming tax rebate pushed through Congress could offset slowing growth.