Floundering economy points to another rate cut

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Rollin’, rollin’, rollin’, keep those rate cuts rollin’ …

That’s what Federal Reserve Board officials seem poised to do when they meet on May 15. After slashing the key federal funds rate by 2 percentage points, or 200 basis points, in a little over four months, Chairman Alan Greenspan and crew will likely tack on another 50-basis-point cut.

Because of rising unemployment, lackluster manufacturing activity and signs that even the almighty consumer is getting weary of spending, policy makers have to keep the cuts coming if the economy is going to stay afloat, experts say.

“Their No. 1 job right now seems to be to avoid a recession and stem job losses,” says Carl Tannenbaum, chief economist at LaSalle Bank in Chicago. “Our call is for another 50-basis-point decline, and I think that that’s really intended not just to address the fundamental situation but also the mental situation of the nation in that it’s designed largely to provide a psychological boost.

“They’re going to be looking at the mindset of consumers and how that may play out with spending,” he adds.

Until very recently, consumers have been relatively sanguine about getting out their wallets and plunking down money for cars, clothes, homes and other things. That has kept the economy going even though companies have been trimming costs by postponing capital investments, cutting back on travel and perks and taking other measures.

But in March, the economy began shedding jobs, and in April more jobs were lost than in any month since the early 1990s. Officials are undoubtedly worried that more bad news of that nature could give the economic downturn a second wind by curtailing consumer spending too.

“The first quarter is currently estimated to have come in at 2-percent growth, which on the surface of it, looks reasonably healthy. But it’s clear the quarter ended more weakly than it began,” says Bill Cheney, chief economist with John Hancock Financial Services Inc. in Boston. “Then we got the April jobs data, which was a huge negative number.

“If you get job losses, you run the risk of a downward spiral,” he adds.

People who lose their jobs are “liable to cut their spending and they’re liable to make their neighbors and colleagues more gloomy. You don’t want that downward spiral to get started, so there’s a reason to be somewhat aggressive to respond to it.”

Cheney thinks members of the Fed’s Federal Open Market Committee, which sets interest rate policy for the broader government agency, will cut the federal funds rate by 50 basis points. There’s an outside chance officials may opt for a larger 75-point cut, says Cheney, but it’s not likely.

Either way, the funds rate will almost certainly drop to at least 4 percent from its current 4.5 percent level. The funds rate is important to consumers because it guides the prime rate, which in turn guides private-market rates — what banks charge on everything from auto loans to home equity lines of credit and what they pay out on certificates of deposit and money market accounts. At 7 percent, the prime rate would be at its lowest level in seven years.

As for home loans, short-term mortgages such as one-year adjustable-rate loans will likely get cheaper after the Fed’s cut, too. But rates on longer-term mortgages, such as 30-year loans, probably won’t change much because Fed cuts don’t directly affect them.

Long-term mortgage rates rise and fall based on the market’s perception of the economy and inflation. With Fed cuts likely to prompt an economic rebound later this year, they could actually rise slowly over the next several weeks as lenders and investors reprice long-term loans to reflect that outlook.

— Posted: May 11, 2001