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Fussing With The Funds Rate


Economic Trends

FUSSING WITH THE FUNDS RATE

The Fed keeps missing its target

On Jan. 31, the Federal Reserve Board's Open Market Committee confirmed market expectations by lowering its target for the federal funds rate--the interest rate that banks pay to borrow overnight money from one another--by 25 basis points, to 5.25%. So what's happened to the funds rate?

As economist William V. Sullivan Jr. of Dean Witter Reynolds Inc. points out, in the 17 trading days following its announcement, the Fed was able to meet or exceed its target on only two occasions. On the 15 other sessions, the effective funds rate averaged a full one-eighth of 1% below the Fed's target.

At the least, this suggests that the U.S. financial system is awash with liquidity. Sullivan thinks one reason may be the recent tendency of commercial banks to attract more cash into savings accounts and to tap other sources such as large certificates of deposit--thus lessening their reliance on federal funds.

But even with this shift, notes Sullivan, a fundamental question remains: Does the lower-than-targeted funds rate reflect a desire by the Fed to be slightly more accommodative than its stated intention--or does the flood tide of cash reflect an unanticipated further slowing of the economy?BY GENE KORETZReturn to top

WHERE MEXICO GETS ITS SALSA

Exports are fueling the recovery

As Mexico's economy finally starts to rebound, it is the nation's export sector that is leading the way, reports economist Alfredo Thorne of Banco J.P. Morgan in Mexico City.

The trend is underscored by Mexico's surprisingly strong trade performance in January. While imports rose to $6.9 billion, nearly 8% above the average monthly level in November and December, exports surged almost 12%, to $7.7 billion. The upshot was a record trade surplus of $779 million.

The results are impressive for two reasons: They come in the face of declines in overall U.S. imports, indicating that Mexican exports are gaining market share in the U.S. and are likely to pick up more as the U.S. economy gains steam. And they reflect a healthy rise in exports to other countries, which normally take only 20% of the total.BY GENE KORETZReturn to top

DIVIDE AND PROSPER

Why investors like stock splits

When publicly traded companies decide to raise capital by offering additional shares to the market, investors who snap up the offerings often take a relative bath (BW--Mar. 27). But those who buy shares of companies splitting their stock do relatively well, report economists David Ikenberry, Graeme Rankine, and Earl K. Stice in a Rice University working paper.

Their analysis of 1,275 2-for-1 splits on the New York and American Stock Exchanges from 1975 to 1990 revealed that split stocks outperformed stocks of companies of similar size and book-to-market values--by 7.94% one year after the announced split and a cumulative 12.14% after three years. Since more than 97% of stock splits occurred among companies whose shares were trading above the median price observed for similar-size companies, the researchers conclude that a prime motive for splits is to maintain share prices within a desired trading range--and thus to possibly improve share liquidity and marketability.

The post-split performance of stocks also suggests that most managers of companies with relatively high-priced stocks choose to split them only if they are fairly confident that the new share prices will not fall too far--below the desired range. So they tend to act when corporate prospects are favorable.

Why does it take the market a year to catch on to most of the favorable information implicit in split announcements? Since stocks usually appreciate about 3.4% when the splits are first unveiled, the researchers conclude that, at least initially, investor enthusiasm is tempered with a healthy degree of skepticism.BY GENE KORETZReturn to top


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