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Commentary: The Fed's April Surprise


To a growing group of Wall Street money mavens, it was beginning to look as if the U.S. economy's gut-wrenching decline might be nearing a halt. Hints of a bottom were provided by new evidence showing that auto makers had worked off excess inventories, investors' spirits were bucking up, and output at the nation's factories had risen in March after a six-month dive. On those million-yaks-a-minute personal-finance TV shows, the chatter turned to the tantalizing possibility of an early spring, as analysts opined that it was buying time again for wary investors.

Then, in one bold stroke, Federal Reserve Chairman Alan Greenspan provided both hope--and trepidation--to the markets. After weeks of orchestrated downplaying of an intermeeting cut, on Apr. 18 the Fed slashed interest rates by another half-point, the fourth such reduction in as many months. The surprise move magnified the potency of the easing, sending the Dow Jones industrial average soaring 4% and boosting the Nasdaq Composite Index 8%.

The extraordinary move again made clear that Greenspan is now overseeing the most aggressive monetary policy regime in his 13-year tenure--indeed, in the central bank's recent history. And market euphoria aside, what the Fed Chairman is signaling by his actions should be a sobering warning to the bottom-fishers: The economy is still poised between a rebound and a miasma of sickly corporate profits, large-scale layoffs, and prolonged stagnation. Why? While individual investors seem more upbeat these days, corporate CEOs are still in a profound funk over eroding profit margins. And their reflexive reaction--deep cuts in capital investment, research and development, purchasing, and payrolls--is acting like a whirlpool that sucks the economy down.

BOARDROOM GLOOM. While past Greenspan rate cuts have been directed largely at individuals and investors, the latest salvo seems targeted squarely at boardrooms. Fed officials say that CEOs they've spoken to have been almost uniformly gloomy. And in a statement accompanying the rate cut, Fed policymakers made clear that the abrupt falloff in capital investment needs to be reversed to give any recovery a fighting chance.

Indeed, the mood in executive suites does seem bleak. The steepness of the economic decline and the sharp erosion in corporate profit margins have left many business leaders thinking and acting as if a full-blown recession were at hand. "It's difficult for us to see that Fed action will have a significant short-term effect for our industry," laments Leonard A. Hadley, CEO of appliance-maker Maytag Corp. Notes Louis B. Crandall, chief economist at consultant R.H. Wrightson & Associates in New York: "Companies are becoming wary of making commitments of any sort." Signs of sustained weakness are everywhere: A battered tech sector could be in for a couple of years of pain, a renewed bout of consumer thrift that has some households shifting from spending to savings mode, and the added complication of slowing global growth--from Asia to Europe to Latin America. Taken together, these factors depress the U.S. economy's ability to spring back, which explains why the normally cautious Greenspan is resorting to sneak attacks and heavy monetary artillery.

What's at stake is no less than the future of the New Economy, not to mention Greenspan's own reputation as the postwar era's reigning economic sage. As Greenspan sees it, the current corporate pessimism risks cutting back investment in precisely the efficiency-enhancing tech gear that underpinned the New Economy boom. As the explosive surge in business investment drove the economy to new heights, productivity and profits took off in tandem, and the U.S. entered a virtuous circle of soaring growth and low inflation. If that begins to unwind, it spells trouble. Falling investment and slower productivity growth could reignite inflation, sending the stock market and the economy onto the skids.

But it may take more than a couple of surprise rate cuts to revive business leaders' animal spirits. "There is no doubt that reducing interest rates is supporting industry demand, but we should not think that you have four rate cuts and everything is fixed the next day," says Chrysler Group CEO Dieter Zetsche. Boeing CEO Philip M. Condit agrees. He says that any recovery from a slowdown this steep is likely to be gradual--more in the shape of a U than Greenspan's once-vaunted V. "There are [still] imbalances that need to be addressed," Condit says.

Many of those imbalances, of course, are in the battered technology sector. But tech isn't the only headwind that the Fed has to fight. Consumer spending is showing signs of slackening as well. After a decade of running down their savings, workers are feeling the pinch from everything from a faltering stock market to rising energy bills. Adding to their anxieties is the constant drumroll of layoff announcements.

OMINOUS. Meanwhile, many family balance sheets have entered the danger zone. Home borrowers are mortgaged to the hilt, which could put lenders at risk if they have trouble making payments. Already, late credit-card payments are rising ominously. "Household finances are deteriorating," says Allen Sinai, chief economist for Boston consultants Primark Decision Economics Inc. As a result, both retail sales and housing starts dipped in March--in what some economists fear could be the start of an extended period of retrenchment. "Companies are executing massive layoffs," says Scott D. Miller, president of Hyatt Hotels Corp. "Anything [the Fed] can do to bolster people's confidence will help."

As the Fed's April surprise shows, the central bank is prepared to go all out to stem the economy's decline. But the rapid rate cuts are not without risks themselves. Such a course holds the possibility of stoking inflationary pressure. But because Greenspan remains firmly convinced that the marvel of the New Economy can lower inflation and boost productivity, the Fed Chairman is more than willing to take that chance. That's why from here on out don't be too surprised if Greenspan keeps right on cutting rates. By Rich Miller and Laura Cohn

With Joseph Weber and Michael Arndt in Chicago, Stanley Holmes in Seattle, and Joann Muller in Detroit


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