Investors look to Federal Reserve as US economic growth slows down

Investors look to Federal Reserve as US economic growth slows down
AGENCIES

NEW YORK, DEC 16: The stock market is slipping and sliding in a way that experts say could be a sign of recession, and Wall Street’s big fear is that Federal Reserve chairman Alan Greenspan has pumped the brakes so hard to slow the economy he may not be able to avoid a fatal skid.

Investors are looking to the Fed chief for help in restoring stability to the market and ensure the current economic slowdown doesn’t accelerate into something worse.

After all, the central banker contributed to the raising interest rates six times from June 1999 to May this year to keep the fast-growing economy from revving up inflation. The concern is that even if Greenspan acts quickly to lower interest rates early next year, it may be hard to keep the cooling economy from avoiding a recession. The reason: it takes up to nine months for policy changes to filter through and by that time, the economy could be dead in the water.

Also, Greenspan may have taken it to the limit by raising rates six times, causing an unbearable deceleration in growth. The proof: consumer confidence and economic growth slowed in the third quarter to a pace unseen in four years. Simply put, the tough Fed remedy to cure a weak inflation bug may have killed the patient.

The central bankers will meet on December 19 to take another look at the economy. The betting is that they will shift their focus from inflation and adopt language that zeroes in on the risk of an excessive slowdown. This would lay the groundwork for an eventual rate reduction early next year.

The damage, however, has been done. The Nasdaq market has suffered a nose-bleed fall of nearly 50 per cent from its March high, and a loss of more than 30 per cent for the year. The Dow Jones industrial average, which is on track for its first down year since 1990, has lost more than 7 per cent this year.

"The worst case scenario would be if the Fed does nothing at its December meeting and maintains its tight money policy," says Allen Sinai, chief global economist at Primark Decision Economics Inc. "Stocks would go lower and the economy would decelerate faster."

Sinai’s bet: The Fed will tilt to a neutral policy in December and perhaps follow up with an interest-rate cut at the policy-setting meeting on January 30-31. The first reduction in interest rates could be one of the few rays of sunshine on Wall Street in the New Year.

"What may work in the Fed’s favour is that there will be the perception that once it starts to cut, there will be a series of easings through the next two years with a total drop of 150 basis points," says Sinai.

The economy grew in the second quarter at a tremendous rate of more than 6 per cent year over year, but growth by the middle of next year will slump to 3 per cent or possibly 2 per cent.

Experts say that such a stressful drop in growth would be too much for the world’s largest economy to handle. The speedy deceleration from boom to subpar growth will also have a chilling effect on the forward planning of businesses, which are already slashing their capital spending on new technology and other productivity-boosting things. Corporate capital spending, which soared to $1.9 trillion over the last 10 years, had a big role in fuelling the nation’s record economic growth.

"The message we are all getting is that there is a very different backdrop out there," says Sinai. "We are at a different phase of the business cycle after 10 years of growth." He adds, "In this ‘New World,’ an economy that grows by 2 per cent or less, will feel like an ‘Old World’ economy felt when there was zero growth."

The field reports are in from the Fed’s pre-emptive rate strikes. The rate boosts totaling 175 basis points from June 1999 to May this year were supposed to bring the economy to a soft landing. That scenario has gone out the window and Wall Street is pricing in a nastier script - a hard landing, or worse, a recession - that brings a high jobless rate and personal and corporate bankruptcies.