BUSINESSWEEK ONLINE : DECEMBER 18, 2000 ISSUE
BUSINESS OUTLOOK U.S.: Greenspan to the Markets: Stop Worrying So Much Credit is tightening. But that's a ''by-product'' of a soft landing Relax, Chicken Little: No less than Federal Reserve Chairman Alan Greenspan says the sky is not falling. For a nervous Wall Street, all but frozen by its fears that the economy was headed to hell in a handbasket, Greenspan's unusually clear assessment of business conditions on Dec. 5 was a welcome dose of reality. The Fed chief's analysis mirrored the pattern of the recent data: They show that less-accommodative financial conditions, the result of past Fed tightening, are restraining, not bludgeoning, the interest-sensitive sectors of the economy. Demand for cars, computers, and other durable consumer goods is growing more slowly. Orders and output in key technology industries are also slowing. As a result, the manufacturing sector is getting hit disproportionately hard (chart), as it usually does when the Fed raises short-term interest rates. Notably, housing has fared relatively well, supported by low mortgage rates and healthy consumer fundamentals. Nevertheless, Greenspan strongly implied a shift in the Fed's thinking: It is becoming less concerned about inflation and more about the extent of the slowdown. His remarks increase the chances of a rate cut next year, but they don't guarantee it. A possible cut is a key reason for the market's warm reaction to his words. The Dow Jones industrial average rocketed up 339 points on Dec. 5, and the Nasdaq surged 274 points, the biggest one-day gain ever, although it remains 43% below its March peak. The chairman, however, made it clear that the economy's current circumstances are ''in no way comparable to those of 1998.'' Yes, credit conditions are tighter, as investors reevaluate the risks associated with handing over their money. But unlike the systemic risks posed by 1998's financial near-meltdown, Greenspan said today's credit-tightening is ''the expected by-product'' of the economy's transition to a more sustainable pace of growth, compared to the previous boom. WHILE THIS IS NOT 1998, the economy is starting to look a lot like 1994. That was the last time the Fed succeeded in bringing a fast-growing and potentially inflationary economy down for a soft landing. For example, the recent softness in manufacturing, the slower trend in consumer goods outlays (chart), the rise in initial claims for unemployment benefits, and the fall in the index of leading indicators, are all--so far--following patterns similar to those in 1994-95. The deja vu is particularly striking in the purchasing managers' index, a composite of industrial activity that measures output, orders, employment, inventories, and delivery speeds. The index fell to 47.7% in November, and it has plumbed that level only twice since the 1990-91 recession: in 1998, following the Asian crisis and its sharp drag on exports, and again in 1994, as the Fed was lifting rates. Both times manufacturing was essentially in its own recession, but the broader economy held up. Also, the factory weakness is showing up in other data. The increase in jobless claims reflects factory layoffs, especially in the auto industry, as Detroit cuts output to pare inventories that have gotten out of line with sales. Also, five of the ten components of the index of leading indicators directly reflect the ups and downs in the manufacturing sector. The index fell 0.2% in October, and it has been in a downtrend since March. EVEN WITHIN MANUFACTURING, the pain of Fed tightening does not fall evenly. While activity in the technology industries has slowed somewhat, nontech is really struggling. Through October, orders in the 89% of manufacturing that excludes computers, peripherals, communications equipment, and electronic components have not grown since the start of the year. Meanwhile, the composite trend of tech orders, the remaining 11%, shows only a little easing, but no sudden or severe weakness. As Greenspan noted, some slowdown in tech orders is to be expected. ''The orders and output surge this past year in a number of high-technology industries, amounting in some cases to 50% or more,'' he said, ''was not sustainable, even in the more optimistic new economy scenarios.'' A replay of 1994 is also evident between manufacturing and the rest of the economy. That is, the huge service sector, about half of gross domestic product, continues to plow ahead. The divide is especially clear in consumer spending. Outlays for services over the past year are growing slightly faster than they were this time in 1999, while goods purchases have slowed sharply, led by durables. ONE SECTOR STANDS as an anomaly in the Fed's effort to cool this economy. Housing, usually the central bank's other victim, has remained quite solid in the face of tighter monetary policy. In his speech, Greenspan pointed out that although homebuilding has declined through much of the year, ''more recently, demand appears to have largely stabilized'' in response to a drop in mortgage rates since the spring. True, new home sales fell by 2.6% in October, to an annual rate of 928,000. But that slip followed an 11.9% surge, and October sales are above their year-ago pace. Other data suggest that housing should end the year on an upbeat note. The Housing Market Index from the National Association of Home Builders has been creeping higher since June. And new-home mortgage applications were still high in early December (chart). Why hasn't Fed policy pummeled housing yet? One reason is that credit conditions for consumers have not tightened all that much. The average rate for a 30-year fixed mortgage is about where it was when the Fed began lifting short-term rates in June, 1999, and at 7.65%, the rate is a percentage point below where it stood last May. The Fed's own survey of senior loan officers shows that banks have not tightened their credit standards on mortgages one iota, even as they have raised the bar for business borrowers. Equally important, consumer fundamentals still haven't fallen to the levels associated with a soft landing. The downturn in job growth is nowhere near as severe as it was from 1994 to 1995. Real incomes are currently rising at a yearly rate of 3%. They grew at about 2.4% during that soft landing. And consumer confidence, though down from its recent peak, is much higher than it was six years ago. That's not to say that the housing market is totally insulated from risk in 2001. Jitters in the bond market could boost mortgage rates. A renewed uptrend in oil prices could cut into real income growth. And a sharp sell-off in the stock market could further squeeze both consumer confidence and the wealth effect. Greenspan recognized that an economy shifting to slower growth is at risk for unanticipated events. But his speech made it clear that a batch of soft numbers does not mean a recession is around the corner. And fears of economic collapse are overblown. By JAMES C. COOPER & KATHLEEN MADIGAN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS U.S.: Greenspan to the Markets: Stop Worrying So Much CHART: Manufacturing Enters the Soft Landing Zone CHART: Where Consumers Are Pulling Back CHART: Housing Demand Remains Healthy INTERACT E-Mail to Business Week Online

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