Fed drops rates another 50 basis points

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Federal Reserve Board officials slashed interest rates by one-half of a percentage point for the third time in three months on March 20, warning that a slowdown in manufacturing, falling stock prices and tight corporate profit margins were hampering economic growth.

While the 50 basis point move was smaller than some market watchers hoped for, Fed officials said in a
post-meeting statement that they would closely monitor the economy for signs of further deterioration. That suggests further rate cuts could come at the agency’s next policy setting meeting on May 15 — or sooner.

“Although current developments do not appear to have materially diminished the prospects for long-term growth in productivity, excess productive capacity has emerged recently,” the statement said. “The possibility that this excess could continue for some time and the potential for weakness in global economic conditions suggest substantial risks that demand and production could remain soft.

“In these circumstances, when the economic situation could be evolving rapidly, the Federal Reserve will need to monitor developments closely.”

Tuesday’s meeting was only the second of eight scheduled this year for the Fed’s Federal Open Market Committee. The group, which sets interest rate policy for the full board, voted to lower the federal funds rate to 5 percent from 5.5 percent and the federal discount rate to 4.5 percent from 5 percent. The most recent cut comes on the heels of two 50-point reductions in January. Cumulatively, policymakers have reversed all but 25 basis points of the hikes they pushed through in 1999 and 2000 to ward off inflation.

The benchmark federal funds rate guides the private-market rates banks charge on everything from home equity loans to credit cards, as well as the rates they pay out on certificates of deposit. Because of the most recent Fed cut, borrowers will be able to get even cheaper loans, but savers won’t earn as much on their CDs and money market account balances.

Rates will likely fall further, too.

Consider that the Fed includes one of three sentences in its post-meeting statements: One says inflation is the primary threat to the economy, one says excessive weakness is the main problem and one says things are just right.

On March 20, the Fed used the direst of the three, saying it “continues to believe that against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future.”

“Mr. Greenspan is going to wait and see how economic conditions play out in the future, but he certainly left the way open for an inter-meeting cut if they need to,” says Bob Baur, managing director of economics and analytics at Invista Capital Management in Des Moines, Iowa. He’s “clearly looking out for more weakness.”

Business investment remains weak, the stock market is doing poorly and manufacturing activity has slowed substantially, Baur says. That suggests the Fed will cut rates further.

On the other hand, the unemployment rate hasn’t shot up and consumer spending on big-ticket items, such as cars and houses, seems to be holding up fairly well even though confidence has fallen. While that doesn’t preclude the Fed from cutting further, it may keep officials from slashing rates in the dramatic fashion they have so far this year.

“Alan Greenspan is still the master of gradualism,” Baur says. “Alan is going to continue to watch the economy and monitor economic conditions, but I think he’s confident, at least at the moment, that the economy has not moved into recession.”

— Posted: March 20, 2001