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January 4, 2001

Fed's Surprise Move Sparks Rally, Sets Off New Jitters About Economy
By Jacob M. Schlesinger, Greg Ip And Nicholas Kulish, The Wall Street Journal

Fed Rate Cut Can't Stop Nose-Dive ... Weiss comments

WASHINGTON -- With the fate of the economy, financial markets and his sterling reputation on the line, Alan Greenspan delivered a New Year's surprise: a large, emergency interest-rate cut that instantly brought smiles to Wall Street.

But as financial markets celebrated, some took the Federal Reserve chairman's dramatic action as a potentially ominous sign: that the nation's top economy watcher may see a recession at hand.

"This says to me that Alan Greenspan is considerably -- not just a little, but considerably -- more worried about the health of the economy than the consensus forecasts," said Princeton University economist Alan Blinder, who served as Mr. Greenspan's vice chairman from mid-1994 through early 1996. "And if things are deteriorating as rapidly as Greenspan must think, this will not be enough to stop the deterioration," Mr. Blinder added.

At a hastily arranged hour-long conference call with Fed colleagues from around the country Wednesday morning, the chairman engineered support for a cut of one-half percentage point in the central bank's main policy tool, its target for the federal funds rate used by banks for overnight lending, to 6% from 6.5%.

Wall Street's reaction to yesterday's rate cut is clearly another case of irrational exuberance. The bulls stampeded toward the nearest media outlet and hurriedly predicted that the Dow will soar to 15,000 and the Nasdaq is back on track to hit 6,000 or higher. But, the 300-point gains posted by both the Dow and the Nasdaq will melt away once investors recognize that the Fed's rate cut has merely loosened the brakes on the economy's headlong rush toward a collision with recession.

Already, the market's rally is sputtering. Reason: investors still see fundamental problems penetrating the economy. To justify its rate cut, the Fed prepared a laundry list of recessionary menaces -- weak sales and production, tight conditions in financial markets, low consumer confidence, and high energy prices sapping household and business purchasing power. A half-percentage point rate cut won't make these problems go away.

The credit crunch is here to stay. Burned by bad loans, banks have cut off easy credit, and many businesses are too debt laden to keep borrowing no matter what the rate. Plus, many banks that were quick to raise their price rate following the Fed's rate hikes have yet to lower those rates. And consumer confidence continues to slide as individuals worry about jobs and feel the burden of credit card charges and big-ticket purchases made during the bubble economy. All of these factors will keep corporate profits low or negative and earnings reports will continue to disappoint investors -- dragging the market even lower. Plus, as corporate profits plummet, businesses will be forced to layoff workers, shoving consumer confidence even lower.

The Fed rate cut will do nothing to stop the economy's death spiral. In fact, by cutting rates now, it may hasten the end. The stock market was leveling out into a holding pattern before the move. Now, the Fed has let the market know there is good reason to fear a recession. Many investors are going to wise up, take profits from yesterday's rally and exit the market before the hard landing resumes.

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