Market News International - The Federal Reserve derived little comfort from the fact that the weak April reading on consumer confidence announced Tuesday was taken before the Fed's surprise interest rate cut last week.
The Fed remains quite concerned about the level of consumer and business confidence and its implication for final demand, sources say. Nor is faltering confidence the only cause for Fed concern about the strength of demand. Sources also point warily to mounting lay-offs, high household debt levels and likely lagged effects from past stock market losses.
The Fed has not given itself over to pessimism by any means. It still hopes employment and income growth will continue to be sufficiently positive to keep consumption growing and enable companies to work down excess inventories and production capacity, while avoiding painful cutbacks. But sources say there is enough risk of a more negative scenario to necessitate the precautionary steps the Fed has been taking.
The policy consensus is that the Fed is justified in slashing rates -- even at the risk of overdoing it -- to ensure that demand, output and employment do not spiral downward in a cumulative chain reaction.
With last Wednesday's surprise 50-basis point rate cut, the Fed has now cut rates 200 basis points since the start of the year, and officials generally reject outside criticism that they have not been sufficiently aggressive. In fact, some fear the central bank is courting long-run trouble with inflation pressures by easing monetary policy as aggressively as it has.
A monetary "over-reaction" is a real danger, said one official. But most officials believe the Fed has had no choice but to risk "over-reacting" now and be willing to reverse some of the rate cuts later, once the maintenance of expansion -- and an eventual reacceleration of growth toward the economy's potential -- is assured.
Last Wednesday's intermeeting rate cut had been contemplated at the March 20 Federal Open Market Committee meeting, but did not become certain until Fed Chairman Alan Greenspan convened an 8:30 a.m. conference call, sources indicate.
The Conference Board reported that its consumer confidence index, which had rebounded strongly to a revised 116.9 in March, fell to 109.2 in April. Most of the deterioration came in assessments of current conditions, as a greater percentage of those polled said jobs are harder to get. Expectations also weakened but remained higher than low February levels. Meanwhile, it was reported that same store sales at the major retail chains rose last week and were described as either at or above projections.
The Conference Board polled households before last week's Fed rate cut, leaving in doubt how that surprise move may have affected consumer psychology. But Fed sources doubted whether consumer confidence would have registered significantly higher, even if the poll had been taken after the rate cut, given the recent flood of lay-off announcements.
Despite rising lay-offs and first-time claims for unemployment insurance, employment and income continued to grow in the first quarter, though at reduced rates. This fueled continued consumption growth in excess of production, and the resulting draw-down of inventories has been encouraging to the Fed. But sources pointed out that, as the quarter ended, employment growth slowed and with it consumer spending.
Although stocks have rallied from their lows, Fed officials doubt whether the negative wealth effects of previous stock losses have been significantly reversed. They also worry that household debt service burdens as a share of disposable income have risen to their highest level since the late '80s -- 14.29% in the fourth quarter compared to a 14.38% peak in the fourth quarter of 1986.
The Fed is also concerned about the weak pace of capital investment, as it made clear in its rate cut announcement last Wednesday -- not just because of the contribution business investment makes to GDP, sources say, but also because of what it says about business confidence.
It was to be expected that firms would slow or curtail capital investment spending after a period of rapid growth that created a "capital overhang" in some sectors, sources say, but what is worrisome is their reluctance to make future investments because of doubt whether sales will be strong enough to justify those investments.
The Fed hopes that its easings will bolster consumer demand, speed business adjustments, solidify the capital investment outlook and keep economic weakness from spreading beyond the manufacturing sector. But the Fed knows those rate cuts will take time to make themselves felt. Officials leave no doubt the Fed is prepared to cut rates further.
Sources suggest Federal Reserve Board Vice Chairman Roger Ferguson was carrying an important message, in his role as second-in-command to Greenspan, when he hinted at more easing to come last Thursday, a day after the Fed cut rates.
Ferguson said the economy has been "expanding very slowly" and added, it is "too early" to be convinced the the economy is reaching the end of what he called a "period of quite slow growth." He said lower interest rates should lend support to consumer and business spending, but he said the risks remain weighted "toward economic weakness." And he said "it is an open question" what level of interest rates will be needed to ensure "a return to healthy growth."