The Fed's Pinch Is Finally Causing Some Pain

Until recently, most U.S. corporations seemed almost invincible. Sure, Federal Reserve Chairman Alan Greenspan pushed through six interest-rate hikes in the past 14 months. But profits kept piling up. Now, however, the effects of higher borrowing costs may finally be inflicting some pain.

Warnings about upcoming earnings disappointments have hit the news wires in recent weeks with almost alarming regularity. As of July 31, 26 of the 28 pre-announcements made by consumer-services firms were negative. ''The bulk of these are coming from a slowdown in consumer spending due to higher interest rates,'' says Joseph S. Kalinow-ski, equity strategist at I/B/E/S. Despite strong first and second quarters for most companies, 10 of the 15 technology companies making announcements have warned of lowering earnings or that they expect to just match analysts' consensus, according to earnings tracking firm I/B/E/S. The companies range from retailer Nordstrom Inc. (JWN) to computer-services company Unisys Corp. (UIS). Already, computer makers were whacked in the second quarter when earnings fell 16%.

''MINOR IRRITATION.'' The trend is likely to continue. Borrowing costs are up nearly two percentage points over a year ago. Consumer demand has softened. And companies' ability to raise prices has all but vanished. True, it will take about a year before rate hikes fully filter through the economy, but when they do, watch out. ''Right now, interest rates are a minor irritation, but they will cut into profits eventually,'' says Sung Won Sohn, chief economist at Wells Fargo Co.

That's just what happened the last time the Fed embarked on a year-long tightening campaign, in early 1994. Corporate profits didn't take a big hit until late 1995.

This time around, analysts expect companies in the Standard & Poor's 500-stock index to see earnings gains trending down to 15.7% in the fourth quarter as higher rates work their way through the economy, according to earnings tracking firm First Call Corp. And while most investors believe the Fed's tightening campaign is nearing an end, they also worry about the consequences should the Fed make another move. ''If the Fed has to ratchet up rates again, chances are companies could really get hurt,'' says Cary Leahey, a senior economist at Deutsche Bank Securities.

How badly? Demand for homes, cars, and retail items has already fallen ''considerably'' over the past three months, according to New York researcher ISI Group. ''Companies have been very quick to offer discounts and incentives to spur sales as consumer spending has slowed,'' says Jason R. Trennert, managing director at ISI. That's putting pressure on margins at companies ranging from electronics retailer Best Buy Co. (BBY), which is offering no-cost financing on some appliances, to homebuilder Kaufman & Broad Home Corp. (KBH), which is trying to cut costs through e-commerce initiatives like online auctions for contractors.

What might help companies this year is continued investment to boost productivity. Some 40% of the 127 companies in a July survey plan to boost capital spending in the next six months to become more profitable, according to the National Association for Business Economics. ''Productivity gains are helping to offset Greenspan's rate hikes,'' says Greg A. Jones, chief economist at, an Internet-based financial adviser in Burlingame, Calif.

Such gains can't come soon enough. If companies fail to achieve them, it's going to be tough to sustain profits. That's when those six hikes will really take a bite.

By Laura Cohn in Washington

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Still Flying with a Full Tank

TABLE: Winners and Losers in Quarterly Profits

The Fed's Pinch Is Finally Causing Some Pain

TABLE: The Second Quarter 2000 Corporate Scoreboard (.pdf)

CHART: Aftertax Profits Quarter by Quarter

CHART: Change in Aftertax Profits from 1999

E-Mail to Business Week Online

Copyright 2000-2009, Bloomberg L.P.
Terms of Use   Privacy Notice