The Comeback Economy

The Fed isn't worried about a surprisingly robust first half

The mood at the Federal Reserve's marble headquarters didn't match the party atmosphere over at the White House, where President Clinton's economic team stopped just short of breaking out the champagne. But the central bankers' air of quiet satisfaction was no less significant. "We've been through the snow, the strike, no data, bad data, and still this economy is right on track," brags a Fed official. "It's looking good."

The cause for all this celebration: a string of reports showing a surprisingly strong U.S. economy. Gross domestic product, the economy's total output after inflation, rose in the first quarter at a 2.8% annual rate--a full point higher than most economists expected. The May 2 GDP report featured a sharp 14.5% increase in capital spending, evidence that the 1990s' investment boom hasn't ended. Upbeat reports on consumer confidence and manufacturing boosted hopes for a strong spring as well. Even a weak hiring report for April--when businesses added a scant 2,000 jobs--didn't squelch the optimism.

As usual, Wall Street's party-poopers panicked in the face of good news. The rate on 30-year Treasury bonds rose above 7% for the first time in a year as traders feared a booming economy will set off inflation and force the Fed to tighten. And as usual, the Street is overreacting. From May 1 through May 7, the Dow Jones industrial average fell 154 points, though it rebounded by 53 points, to 5474, on May 8.

True, the economy looks stronger than forecasters, including many inside the central bank, had expected for the first half of this year. But Fed Chairman Alan Greenspan is taking the news in stride. With the economy held back late last year by slowing inventory growth, Greenspan anticipated a sharp gain in early 1996--and expects similar growth for the April to June quarter.

Unlike the financial markets, the Fed isn't upset by good news. Rather than enforce a speed limit on the economy, as it's frequently accused of doing, the central bank wants to let the expansion run until it sees warning signs of rising inflation. And with businesses adding new production capacity at a 3.8% annual clip, Greenspan & Co. see little pressure on prices, outside of unusual spikes in grain and gasoline prices. The rise in bond rates also will make the Fed's job easier, cooling the economy later this year before it can overheat. Put it all together and "the odds strongly favor moderate growth and contained inflation," says Philadelphia Federal Reserve Bank President Edward C. Boehne. Translation: Don't look for the Fed to move short-term interest rates either up or down before Election Day.

Just three months ago, a sidelined central bank seemed unthinkable. When the Fed last cut rates on Jan. 31, the economy looked so weather-battered and weak that Wall Street was giving recession bears a hearing. In March, 8 of 15 economists polled by Laurence H. Meyer & Associates--the St. Louis consulting firm headed by Clinton's newest Fed nominee--were still predicting further Fed easing. But the latest data have put the kibosh on that. Now, no one on the panel expects rate cuts. Two economists predict hikes by August.

SOLID GROWTH PATH. The sudden swing from apparent bust to boom has many forecasters questioning the upturn's strength. First-quarter GDP was boosted by "strange fluctuations that all piled up on the plus side," says Gordon R. Richards, chief economist for the National Association of Manufacturers. Consumers' post-Christmas shopping spree, boosted by Detroit's car rebates, will sap spending later in 1996, Richards argues. And the Commerce Dept. can't explain how the GDP shows big purchases of computers and other capital equipment when some manufacturers' shipments show slower sales.

But even if the 2.8% estimate is revised downward, the economy remains on a solid growth path. That's evident in inventories. Take the computer business: In January, with warehouses bulging, personal-computer makers stopped buying chips and components. But then PC sales surprised many by staying strong--Hewlett-Packard Co. posted a 64% gain in unit shipments over 1995's first quarter. Compaq Computer Corp.'s sales rose 27%. And market forecasts have brightened. Researchers at Dataquest Inc. now predict 19.1% PC sales growth worldwide, down from 25.6% gains in 1995 but "far from a difficult year."

Equipment makers also see ongoing strength. Giddings & Lewis Inc., the largest U.S. machine-tool maker, has steady sales to small manufacturers, who must upgrade their equipment to cut costs. Xerox Corp.'s new-generation copying and printing equipment is fueling sales gains of 5% in the U.S., nearly twice the rate of expansion in the economy overall, and faster growth overseas, especially in Latin America.

Aircraft sales are booming, accounting for most of a 1.5% jump in total factory orders in March alone. Boeing Co. announced it would hire 8,200 workers to lift its monthly production rate from 17 planes to 27 over the next 12 months. Even commercial building is emerging from its long post-1980s' hangover. Atlanta builders, busy finishing Olympic facilities, have orders stacked up for after the Games, while midsize markets across the U.S. are seeing rising rents and pent-up demand for office construction.

In Detroit, second-quarter auto production will be 6% higher than in 1995. Buoyed by consumer confidence, industry economists are raising their 1996 sales forecasts for cars and trucks by 100,000 to 200,000, to 15.3 million. And overall job growth--which averaged 166,000 jobs a month through April--makes retailers hopeful their 1995 slump is behind them: "It seems like the consumer is in good shape," says J.C. Penney Co. economist Ira A. Silver.

By midyear, however, higher interest rates could start to bite. The rise in bond rates since January has already choked off mortgage applications, especially for refinancings, leaving consumers less flexibility to deal with near-record debt. High rates will squeeze household and business spending. But even with a slower second half, GDP is likely to grow by 2.3% for the year. "Six years into an expansion, this sort of sustained growth looks very good," says Lehman Brothers Inc. chief economist Allen M. Sinai.

PALPABLE RELIEF. Nowhere does it look better than at 1600 Pennsylvania Ave. Though they're wary of sounding too bullish--and angering voters fearful of job losses and slow wage growth--Clintonites can't help crowing. "Look at what businesses are doing--they're investing," says Treasury Secretary Robert E. Rubin. "That's a validation of our policies." For political aides, the relief is palpable: "The numbers have killed the Republican effort to talk about a `Clinton crunch,"' says a senior official in the White House.

Well, not quite. GOP nominee-in-waiting Senator Bob Dole (R-Kan.) and other Republicans seized on April's weak jobs report to blast the "treadmill economy" in which people work ever harder but never get ahead. "Clinton's high-tax, big-government policies have sucked life out of the economy," charges Republican National Committee Chair Haley Barbour.

Whose version of the economy will voters recognize? Based on growth and inflation rates alone, "this election is too close to call," says Yale University political economist Ray C. Fair. But if the numbers keep living up to the Fed's expectations, the White House should keep its champagne well chilled.

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