Fed Cuts Benchmark Interest Rate Once Again - WDAM-TV 7-News, Weather, Sports-Hattiesburg, MS

Fed Cuts Benchmark Interest Rate Once Again

Is the U.S. in a recession? Probably so, although you wouldn't know it from two key announcements on Apr. 30 by the Commerce Dept. and the Federal Reserve.

In a split decision, the Federal Reserve cut its key interest rate again. It said that "economic activity remains weak," but added that its measures "should help to promote moderate growth over time." The action came hours after the Commerce Dept. reported that gross domestic product grew in the first quarter. The increase was a meager 0.6%, the same as in the fourth quarter of 2007, but it was still above zero.

Economists sifted the Fed's statement for hints of whether the Fed was done cutting but there were no obvious clues, indicating that the Fed doesn't want to paint itself into a corner on future actions.

With the quarter-percentage-point cut in the federal funds rate-to 2%, its lowest rate since December, 2004-"the Fed is buying extra insurance against a deeper recession," said Arun Raha, senior economist for Swiss Re, in a statement released minutes after the Fed's 2:15 p.m. Eastern time announcement.

The Fed steered clear of any mention of recession. It said, "Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters." On inflation, the Fed said it "expects inflation to moderate in coming quarters."

Domestic Consumption Falls

The decision was split because two voters on the Federal Open Market Committee-Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser-"preferred no change in the target for the federal funds rate at this meeting." As usual, the Fed cut the discount rate by an equal amount, to 2.25%.

The GDP report, showing a 0.6% annualized rate of growth in the first three months of 2008, probably overstated the actual health of the economy. On closer scrutiny, the report shows the most weakness in 17 years in actual domestic demand for goods and services. That means the pressure is still on the Federal Reserve to keep cutting interest rates.

All of the meager growth was accounted for by a pileup of inventories. In other words, the economy produced a lot of stuff that went onto the shelf because of insufficient demand. The measure that shows the actual consumption of goods and services within the domestic economy fell at an annual rate of 0.4%, the first decline since the fourth quarter of 1991. That crucial indicator-"real final sales to domestic purchasers"-did not fall at all in the 2001 recession.

There was a bit of good news on the inflation front. The measure of inflation that the Federal Reserve heeds the most rose at an annual rate of 2.2% in the first quarter, down from 2.5% in the fourth. That's only a tad above the top of the Fed's comfort range for that inflation measure, namely 1% to 2%. (That measure excludes food and energy, which tend to fluctuate a lot. Including food and energy, the GDP inflation measure rose at a 3.5% pace.)

Business Investment Weak

In a separate report, the Labor Dept. said on Apr. 30 that employment compensation for civilians, which covers both wages and benefits, rose 0.7% in the first quarter, the smallest increase in two years. That comes out to an annualized rate of just under 3%.

Stock prices rose in early trading after the premarket-opening release of the GDP report, perhaps in relief that the headline number for GDP growth came in roughly in line with expectations. The Dow Jones industrial average was up 84 to 12,916 as of 11 a.m. But the market's reaction is no assurance that the report was actually strong. "There are some very troubling signs in this report," wrote Paul Ashworth, who follows the U.S. economy for London-based Capital Economics. Ashworth noted that inventory accumulation alone added 0.8 percentage points to first-quarter growth.

Business investment in plant, equipment, and software was weak as well. It fell at a 2.5% annual rate after rising at a 6% rate in the fourth quarter. That's important because business investment is one of the most volatile segments of the economy, and can contribute to a recession when it suddenly drops a lot.

The worst-performing sector of the economy? Homebuilding, naturally. Residential construction investment fell at an annual rate of 26.7%, the most in 27 years. Consumer spending grew, but at a pace of only 1% per year.

Key Jobs Report Due

Export growth grew at a 5.5% annual rate, which was good but actually below most economists' expectations, possibly due to seasonal quirks in the data. Michael Englund of Action Economics said he had expected growth of closer to 10%, noting that manufacturers have been taking advantage of the weaker dollar to ramp up foreign sales. Following a recent trend, on Apr. 30 both General Motors and Procter & Gamble reported strong sales outside the U.S. in the first quarter, reflecting the dollar's weakness as well as healthier growth abroad.

Surprisingly, the U.S. economy may well be in a recession even though GDP growth was reported in positive territory. For one thing, the Apr. 30 report is merely an "advance" estimate that will be updated twice more in coming months, and possibly revised again in future years as new information becomes available. It could turn out that output actually declined in the first quarter. For another thing, GDP growth is only one of the factors considered by the National Bureau of Economic Research-the official arbiter of the U.S. business cycle-in concluding when recessions begin and end.

Employment is another key indicator as to whether the economy is in recession, and it fell in January, February, and March. The jobs report for April will be released on Friday, May 2. Even if it shows an increase, the trend could still be downward. Merrill Lynch North American Economist David Rosenberg recently wrote: "The reality is that employment almost always goes down slowly at first, and then heavily as the recession gains force-typically, the worst month for payrolls is the ninth month of the downturn."

President Bush on Apr. 29 gave his darkest assessment of the economy yet, saying the nation was in "very difficult times, very difficult." He said there were no easy solutions, adding, "If there was a magic wand to wave, I'd be waving it, of course." Bush did say that his Administration's $168 billion economic-stimulus package, which includes tax rebates that began this week, should help get the economy moving again soon.

Peter Coy is BusinessWeek's Economics editor.

Reprinted from the April 30, 2008 edition of BusinessWeek.com by special permission
Copyright 2008 by The McGraw-Hill Companies

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