Is All This Stimulus Necessary?
Maybe it's time to take a deep breath. Headlines are blaring recession as if it were a fact, not just a fear. Overseas markets are tanking on bets the U.S. will lead a global downturn. Most important, U.S. policymakers, especially at the Federal Reserve, are scrambling into emergency mode. Except for housing, though, where the latest news on sales and prices is as bad as ever, other data have been mixed and more indicative of a sharp slowdown in economic growth than a broad-based contraction in activity.
That said, the economy's weak 0.6% growth rate in the fourth quarter means recession is a clear and present danger, and policymakers have to manage that risk by acting preemptively. However, as the economics team at JPMorgan Chase (JPM) recently put it, this is "risk management on steroids." Longtime economy and market watcher Ed Yardeni, who heads his own research firm, said it best in a recent note to clients: "I don't recall so much policy stimulus and so many bailout plans thrown at the economy so fast before there was compelling evidence of a recession." It all raises a new question for the outlook: Does this megadose of anti-recession medicine fit the disease?
Start with the Federal Reserve's half-point cut on Jan. 30 in its target federal funds rate, to 3%, coming only eight days after an unprecedented three-quarter-point reduction. Those actions take the inflation-adjusted rate down to about 1% (chart). That is well below the 2.4% long-run average that is generally associated with a neutral policy that neither boosts nor restricts economic growth. The cuts put policy far into the stimulative zone, and the Fed has taken it there faster than at any time since it began targeting interest rates in the mid-1980s. Plus, the Fed’s Jan. 30 statement leaves open the possibility of further cuts.
Then there's some $150 billion in fiscal stimulus on the way. Right now, economists can make only guesstimates about its likely impact, based on similar programs in the past. There's uncertainty over how much of the rebates will be spent, saved, or used to pay debt. Most believe the proposed $100 billion in tax rebates and about $50 billion in capital spending incentives could add somewhere between 1 and 1.5 percentage points to economic growth during the second half.
Recovery Just Around the Corner?
All this policy power comes on the heels of news that the economy barely grew in the fourth quarter, measured by real gross domestic product. However, the 0.6% headline number may be overstating the weakness. The main drag, outside of another plunge in home construction, was a big swing in inventories, from accumulation to liquidation. Excluding inventories, overall demand rose a far-from-weak 1.9%, led by a solid 7.5% advance in business outlays and a 2% gain in consumer spending. That means stockpiles are very lean relative to sales heading into early 2008, which reduces the chances of major production cutbacks.
None of Washington's pump priming will have a material impact on how much the economy slows this quarter and next. Looking across this valley, though, a recovery is starting to come into view. One plus from lower rates is already showing up at the heart of the credit mess, in the mortgage market. The average rate on conventional 30-year fixed mortgages has fallen to 5.6%, down a full percentage point since last summer. That may not be boosting sales, but refinancing activity is skyrocketing. The volume of refis on Jan. 25 had more than tripled since late December, to the the highest level in 4½ years. Lower fixed rates will help ease mortgage defaults by lowering monthly payments and facilitating the shift away from onerous adjustable-rate mortgages.
If the recessionists are wrong and the economy plods along through the first half, it might end up recovering on its own in the second half, just as the full thrust from the monetary and fiscal actions kicks in. Before the year is out, investors could be face to face with a Fed suddenly intent on hiking rates out of fear that an overly hot economy will push up inflation.