Hang in there.
That's the message from the
Federal Reserve, which in cutting rates today wasn't talking to the consumer or the stock market, but directly to the companies currently in the midst of a profits recession and still, despite some tentative signs of recovery, facing at least two more lousy quarters.
The move -- which comes at a time when
sentiment seems to be improving -- is aimed at restoring confidence among businesses, to try to stem the bleeding in the business sector from carrying over to the consumer, thus putting the entire economy in the emergency room. The cut comes as a bit of a surprise now, because it's happening just as the markets are reviving the belief in a second-half recovery. But the early evidence from companies is that any recovery is only crawling -- and the Fed wants it to walk.
"The issue of doing it now is entirely a confidence story," said Bill Cheney, chief economist at
John Hancock Financial Services
. "I think it's an economy confidence story."
Fed: This Is Unacceptable!
The Fed's statement makes it clear that it's the business sector it's most concerned about now. Whereas previous statements described the Fed's concerns about a multitude of economic factors, they were focused mostly on consumer demand and inventory management. But this
statement contains a warning that the economy could continue at an "unacceptably slow pace" if business investment doesn't recover.
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"Capital investment has continued to soften and the persistent erosion in current and expected profitability, in combination with rising uncertainty about the business outlook, seems poised to dampen capital spending going forward," the statement said.
And it should be concerned. While consumers, for the most part, have been motoring along, the business sector has been sputtering. The economy entered a profits recession in the fourth quarter; business investment, after leading the economic boom through 1999 and 2000, slumped badly at the end of the year. Confidence among chief executives dropped to its lowest level since the recession of 1980. There's a nascent recovery in the manufacturing sector, judging by comments from automakers and the most recent industrial production release, but by no means is it on solid footing yet.
"There wasn't any particular economic number, although it's an economic argument," says David Jones, chief economist at
Aubrey G. Lanston
. "If you have a boom-bust investment spending cycle, along with an inventory correction, you can extend the economic downturn."
Please, No More Firings
Were this to continue, the business decline would be on course to collide with a consumer still busily spending money. Companies, beset with overcapacity and large debt burdens, would have to continue to cut back on spending due to squeezed margins. Anticipation for slower revenue growth would further this trend, and have the added effect of causing layoffs across more sectors of the economy.
For quite a few months companies tried to maintain their staffing levels. Unemployment did rise, but only very slowly, though it seems to have accelerated in the last couple of months. Some sectors were hurt badly in March -- not just manufacturing, but also temporary help (hired mainly by manufacturing companies) and the retail trade sector (which showed significant declines in March).
Preliminary readings on consumer sentiment in April showed another decline in confidence. It hasn't hit the breaking point yet for consumers, because job security remains strong enough and the lure of cheap borrowing has kept people spending money. But without a rebound in business conditions, lower interest rates would serve only to help people continue leveraging their balance sheet just in time for unemployment to rise and spending to plunge.
That most recent jobs report supports
Greenspan's concern that a breach in confidence that pushes the economy from slow growth into a recession, something he discussed in January, could occur in the coming months. In effect, what today's cut represents is a message to companies telling them to eat some lousy profits for a few more quarters and hold on to employees, because ultimately the economy will turn around.
"Fundamentally, we're going into a capital stock correction," said Mark Wanshel, financial economist at
J.P. Morgan Chase
. "Capital spending is likely to be weak for the next several quarters. In that kind of environment, anything that disturbs the consumer can snowball on the downside."
What's different about this rate cut from the Jan. 3 surprise cut, however, is that in January, businesses were only seeing their outlooks worsening -- if they could see an outlook at all. The surprise cut then seems to have been meant to bolster sentiment in the market (which it did, fleetingly) and start the committee on the path to lower interest rates. However, in January, the funds rate, at 6%, was still restrictive, which is why January's rally had no teeth.
This is all very nice, but why would the Fed wait until now, when the business sector has been suffering for weeks? There are a couple of reasons. The Fed is loath to be looked upon as having to "save" the stock market, and with stocks on a two-week rally, that's a hard contention to make now. In addition, they likely wanted to view the entire slate of March data, including the inflation reports, before making a final decision. With that final confirmation that inflation indeed was not a problem, they felt free to cut interest rates prior to the May 15 meeting.
It doesn't necessarily mean that they aren't going to do it again, though. The funds rate is now back into territory that economists consider closer to stimulative, and the statement expresses enough concern to show that the Fed isn't going to stop cutting rates just because they're no longer hindering the economy. On May 15, it won't be a surprise -- unless the spry Fed pulls a rate cut on the 14th, just on a goof.