Now, It's Up To The Economy

The Federal Reserve's job, the cliche runs, is to take away the punchbowl just as the party gets going. This time, the Fed has the painful job of telling arrivals not to even think about having a drink.

Throughout the economy, the realization is spreading that the Fed has provided about all the interest-rate relief that it's going to. As a result, the recovery, when it comes, is unlikely to be a barn-burner.

Still, the downturn's end seems to be coming into view. As the Fed's policy-making Open Market Committee met on May 14, evidence was mounting that the economy may be hitting bottom. New figures show that retail sales rose in March--a sharp revision from early reports showing a steep drop in spending--and remained essentially flat in April. Industrial production stabilized in April, breaking a six-month string of declines. And auto makers nudged up their production plans.

GRUMBLING WITHIN. Even before the latest evidence, Fed Chairman Alan Greenspan, who has been pushing rate cuts for two years, met resistance within the central bank. He had a hard time persuading the Fed's inflation hawks to go along with his Apr. 30 cut in the discount rate. The economic news since then has only bolstered arguments against easing. "With these glimmers of improvement in the economy, Fed easing is history," says Merrill Lynch & Co. chief economist Donald H. Straszheim.

That's no way to please the financial markets. Bond dealers, holding a large inventory of Treasury bonds, aren't happy with the rate outlook. They've marked down the price of a $1,000 thirty-year Treasury bond by $16.63 since May 10, pushing up the yield to 8.34%. The rates outlook also spooked the stock market, where the Dow Jones industrial average lost 106 points from May 9 through May 15.

Corporate treasurers are acting as if they don't expect further rate drops. Although long-term rates haven't declined as much as the short end of the market (chart), "rates are still about as low as we've seen them since 1986," argues Jessica Palmer, head of capital markets for Salomon Brothers Inc. That has spurred corporate issuers to replace short-term and floating-rate paper with more predictable long-term debt.

For Greenspan, sticking with a wait-and-see policy will be like trying to stand still during a hurricane. While the Fed sees signs of recovery--and worries about the inflationary effects of today's actions in six months or more-- executives and politicians want insurance that a respectable upturn will come soon. At the Business Council's May 10-11 retreat, CEOs blasted the Fed chief for not doing more to stimulate growth.

SLOW MEND. Nor will the faint outlines of a recovery calm their fears. "Even though the recession may technically end this summer, it is likely to take somewhat longer before the overall business environment really 'feels' healthy again," reports the council's economists.

The economy's gradual slide into a moderate recession didn't create the sharp price-cutting and economic slack needed to support a rapid upturn in growth. Banks are reluctant to lend, especially to homebuilders. "Even if you can get money, the bank keeps a very close eye on your books," says Diane Cox Basheer, who with Martin K. Alloy runs Stanley Martin Cos., a Vienna (Va.) developer. The tight money will slow housing's recovery. And even optimistic forecasters don't see the overall economy's growth rate topping 3% in the last six months of 1991--less than half the usual pace of recovery.

Such a meager upturn won't do much to increase Greenspan's popularity in Washington. The Fed chief, whose term as chairman expires in August, is still considered an odds-on favorite for reappointment. Although President Bush has often complained about the Fed, he has never aimed straight at Greenspan, who's a solid Administration ally on banking reform and other issues. But other Republicans, who see GOP hopes for major 1992 congressional gains sinking in a sluggish economy, don't hesitate to bash the Fed chief. "There is no great groundswell to get rid of Alan Greenspan, but there's been no groundswell to keep him, either," says GOP strategist Eddie Mahe Jr. "He's seen as the man who brought us a recession."

Greenspan can shrug off the political gripes, and he's prepared to react if the economy is weaker than he expects. "We've got to keep our options open," says a top policymaker. But, he adds, "we can't just prime and prime and prime the pump." Translation: The Fed's willing to bet that growth will soon flow from the economy on its own.