Worried Fed may cut rates Chairman’s words spark market rally

WASHINGTON – Federal Reserve Chairman Alan Greenspan, worried about the economic threats posed by rising energy costs and plunging stock values, signaled that the central bank stands ready to cut interest rates to ward off a recession.

His comments Tuesday triggered a powerful rally on Wall Street that propelled the technology-heavy Nasdaq index to its biggest one-day gain in history – up 274.05 to 2,889.80, an increase of 10.4 percent. The Dow Jones industrial average surged by 3.2 percent to close at 10,898.71, a gain of 338.62 points, its third-largest point gain ever.

An economy downshifting from rapid growth to a slower pace “is obviously at increased risk of untoward events,” Greenspan told a banking conference in New York. In such an environment, he said, it was important to remain alert to dangers posed by “an excessive softening in household and business spending” caused by weakening growth and a falling stock market.

Some analysts said Greenspan’s comments may have been, in part, a response to recent remarks by George W. Bush and his running mate, Dick Cheney, who expressed concerns about a possible recession, saying the economic slowdown showed the need for the Republicans’ $1.3 trillion tax cut.

“Greenspan wanted to explain to the markets that we are not headed for a recession and he wanted to explain to Bush and Cheney that the Fed is on top of the situation,” said David Wyss, economist at Standard & Poor’s in New York.

Investors saw Greenspan’s remarks as an explicit promise that the Fed stood ready to cut rates to prevent the economy, currently in a record 10th year of economic growth, from falling into a recession.

“Greenspan was doing what he has done many times in the past, which is give us a heads up when the central bank is about to change its policy stance,” said Allen Sinai, chief economist at Decision Economics in New York. “He is saying there is only one way to go, towards an easier policy.”

Analysts said it was now virtually certain that the central bank at its next meeting on Dec. 19 would change the wording of its policy statement away from a tilt toward raising interest rates to a neutral stance.

Economists are not expecting a rate cut at the December meeting, but they said rate reductions might begin early next year, especially if there are more signals of a spreading slowdown.

Beginning in June 1999, the central bank has raised interest rates six times to achieve a so-called soft landing in which growth slows enough to keep inflation under control but not so much that the country dips into a recession.

Economic growth slowed to a 2.4 percent annual rate in the July-September quarter, less than half the 5.6 percent spring rate, the government reported last week, with other reports showing weakness this quarter in consumer spending and business investment.

On Tuesday, the Commerce Department said new orders to factories fell a greater-than-expected 3.5 percent in October, raising new worries about the health of the manufacturing sector.

David Jones, economist at Aubrey G. Lanston & Co. in New York, said if the economy does stall, he was looking for as many as three quarter-point Fed rate cuts next year, beginning in March.

“If the Fed believes we are headed for a hard landing, they will ease,” Jones said.

In his speech to a conference sponsored by America’s Community Bankers, Greenspan specifically mentioned as threats to future growth the sharp plunge in stock prices and rising tensions in the Middle East, which he said could send energy prices higher.

But he also stressed that the slowdown, as long as it remained moderate, would put the economy on a sounder footing.

“The pace of economic activity has moderated appreciably,” Greenspan said, noting a falloff in sales of big-ticket items such as homes and autos.

Greenspan said recent increases in the number of Americans filing new claims for unemployment benefits “may be an early harbinger of an easing” of the tight labor market. The Fed had raised rates in large part because of concerns that the lowest unemployment rates in 30 years would generate inflationary wage demands.

He stressed that the current situation is not like the turbulence of 1998, when a burgeoning Asian crisis and a Russian default on its bonds plunged U.S. and global financial markets into a tailspin. At that time, the Fed responded with three rapid rate cuts to restore calm.

“The palpable fear that dominated financial markets at the height of the crisis two years ago is not now in evidence,” Greenspan said.