Which way is the wind blowing at the Federal Reserve? The stormy economic forecast that prompted back-to-back cuts in September and October seems to have brightened. Third-quarter gross domestic product, expected to grow only slowly, surged by 3.3%. Consumer spending grew at a solid 3.9% rate. Productivity was up 2.3%. Even Federal Reserve Chairman Alan Greenspan seemed to lighten up--noting on Nov. 5 that he saw "significant signs" that some abnormally large spreads in bond and debt rates were narrowing.
Still, don't write off the likelihood that the Fed will cut rates by an additional quarter point--bringing the federal funds rate down to 4.75%--before the end of the year. Despite the healthy economic data and revived stock indexes, Fed officials continue to worry that slowing U.S. factories, continuing distress overseas, and unsettled credit markets pose threats to next year's economy. Those factors, they contend, outweigh the risk of overstimulation. "With the economy slowing, I don't think very many people are worried about inflation at the moment," says Fed Vice-Chair Alice M. Rivlin.
So, if Greenspan asks for another cut at the Nov. 17 or Dec. 22 meetings of the Federal Open Market Committee (FOMC), the inflation hawks among the Fed's regional bank presidents are expected to go along so that the economy can have a soft landing in 1999. "They have room to move, and a small cut is cheap insurance," says Mark M. Zandi, chief economist of Regional Financial Associates Inc. in West Chester, Pa.
Why do Fed governors fret that the economy, which is showing surprising resilience now, could succumb next year? They point out that the third-quarter GDP figure included a sharp $57.2 billion buildup in inventories that will depress future production. During the quarter, earnings were down 4% over last year (see page 172). And while the 4.6% jobless rate is still near a 30-year low, consumer confidence is slipping as layoff announcements rise and job creation falls.
While the Fed is obliged to consider the U.S. economy first, Greenspan is also keeping an uneasy eye on the global economy. Brazil's currency has stopped plummeting while the nation works on economic reforms. That, notes one Fed governor, has instilled an "interesting sense of calm." But signs of trouble abound: Retail prices are falling in France and Germany, raising fears of deflation that would keep Europe from pulling its own weight in the global recovery. Asia remains mired in recession, and Japan's sputtering efforts to stimulate its economy offer little help. "The world may have stabilized some, but it still doesn't look good, and may not for a couple of years," says Rivlin.
VULNERABLE. Finally, schizoid U.S. financial markets have put the central bankers on heightened alert. Fed officials warn that spreads in credit markets are still too wide. They also worry that the recent resurgence in the stock market has carried share prices back into the overvalued range, making the market vulnerable to shocks such as more bad news in emerging economies.
To be sure, not all central bankers buy into the gloomy outlook. A top official at a regional Fed bank dismisses slowdown warnings as "more evidence of the marvelous self-correcting economy" that doesn't require a Fed boost. And monetarists, like Cleveland Fed President Jerry L. Jordan and St. Louis Fed President William Poole, are alarmed that the money supply's rapid growth will fuel inflation. So, the Nov. 17 FOMC session promises to be lively.
In the end, however, Greenspan is going to get what he wants. And given the current reading of the economy by Fed officials, the preemptive-strike strategy that Greenspan has perfected since 1994 seems to call for action sooner rather than later.