50 basis-point cut yesterday was expected by most market watchers, including Robert DiClemente, chief U.S. economist for
Salomon Smith Barney
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As for what the future holds, DiClemente is fairly sure the Fed will continue cut the funds rate one or even several more times. And pointing to improved credit, the strong dollar, greater liquidity in the market and inventory corrections, DiClemente sees indications that the cuts are already beginning to affect the economy. He also says that investors should take solace in all of the layoffs and production curtailment, as they will eventually translate into stronger profits for tech companies and non-tech companies alike (for more experts' opinions on the Fed move, see this
TSC: Were you surprised by the 50 basis-point cut?
No. We expected 50. We expected them to keep this tilt in their assessment of risk. We expected them to drop out this mention about close monitoring, given that the next meeting is not that far off.
What we didn't get was any subtle hint of optimism, which the Fed has done in the past. The statement was notable for the lack of any bright spots in its assessment of the economy, and I think that's invited people to speculate that the Fed thinks that it's not done, that, in fact, there could still be further aggressive moves ahead. Whether that's more than one, I don't know, but they're certainly not ready to declare victory.
But what I would caution people is that being aggressive and being downbeat does not mean that they somehow know something the rest of us don't. I think they have demonstrated in recent months that they will be disciplined and measured in their approach, and that's what they are doing: 50, 50, 50. They are moving in a way that is actually contrary to the idea that they somehow know something that we don't know yet.
TSC: That's an interesting comment, because I've read some reports that the Fed is looking at some private economic data that indicates further weakness in the economy.
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I think by now people recognize what the constraints are on the economy. Between the devil theory of the pessimists and these structural pessimists, this notion of a Japanese-style recession is not apt.
TSC: You've said earlier that people underestimate the power of rate cuts on the way up and on the way down. How effective do you think these cumulative rate cuts of 2.5% will be and where do you see the economy headed now?
The near-term dynamic is still very negative and that's ultimately the reason the Fed is being aggressive, even now. After the initial part of the slowdown, it's caught fire in a negative way in the job market and in business investment, and I think those two factors are generating second-stage downturn. Unless you break that chain with lower interest rates, it can really create a lot of downward momentum, this kind of self-feeding momentum where weaker demand creates weaker production, and that generates job losses. Fewer jobs mean less income and less demand, and less demand feeds back again, and you get into this spiral.
I think they are trying to break that spiral. I think there's a tendency for people, whether you are on the up or down part of a cycle, to become impatient because of the lags involved. They reach a point where they think somehow the Fed doesn't matter anymore, and that interest rates are not relevant. People have really come to believe that, particularly because of the tech sector's problems and over-investment, that this is not an interest rate-sensitive economy.
TSC: What signs do you see now that the interest-rate cuts are taking hold?
The capital markets are already showing that underneath it all, the markets do recognize that interest rates are working. This last business survey by the
National Federation of Independent Businesses
showed significant improvement in expectations over the next six months. Even recent consumer surveys, in the face of higher unemployment and energy bills, it's evident that people can see over the valley. They see that interest rates are working to improve financial conditions, and those are very important prerequisites for a recovery.
We have got improving credit trends. Spreads have narrowed. Liquidity is running up toward rebuilding liquid asset positions. Companies are locking in lower costs of funding. The wider yield curve. The resilience in the dollar. A stabilization of the equity market. This is all consistent with the idea that the slowdown is not going to swallow us.
At some point, you've got to be patient, and I think ultimately that's where markets now are
TSC: So, where do you see the economy heading now?
For the first three quarters of this year we are going to be mired at 1% to 1 1/2% GDP growth. The fourth quarter is where we should begin to see some improvement, and certainly next year we would look for much healthier growth in the 3% to 4% range. Of course, it's possible the fiscal policy could play some part in that, but with or without that, the financial conditions are improving.
In fact, the adjustments we are getting now -- the job losses, the production cuts, the cooling off in capital spending -- these are all part of the needed adjustments. As that goes on, you start to build pent-up demand. The bad news now is really at some later date you have a backlog of needs.
TSC: You have made the currently contrarian statement that you don't think technology spending has gone bust.
There is no denying that there has been a sharp curtailment in orders and shipments and production of everything from computers to telecommunications equipment to semiconductors. But even in these cases, we are starting to contain the overhang of inventory, and I still think that this notion that there's this vast overhang of inventory is not a dominating concern.
The magnitude of the overshoot is large in some small sectors, but we believe it's still moderate. The long-term prospects for technology and productivity that flows from it are still quite good.