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Federal Reserve Cuts Interest Rates by Half-a-Point

Aired March 20, 2001 - 2:10 p.m. ET


LOU WATERS, CNN ANCHOR: Well, we're taking a look here at the Big Board in anticipation of the announcement on the Federal interest rate cut, which we're expecting momentarily. The Dow is up almost 40 points. The Nasdaq is also up today, only slightly, about a little over eight points right now.

On the trading floor, many are standing by, waiting for news of the interest rate cuts -- about five minutes away. So what factors are affecting the Fed and its decision today? Last week, both major markets went into a freefall, as you know: biggest drop in 11 years for one week, in spite of some mixed economic news from Washington, which raises the question: What's the best economic barometer here?

Joining us now: Fred Allvine, a business professor from the DuPree College of Management at Georgia Tech, and Lauren Young, a senior writer with "Smart Money" magazine.

Welcome to you both.

Professor, third interest rate cut of the year we're expecting here. Is third time the charm -- or a charm?

FRED ALLVINE, PROFESSOR, DUPREE COLLEGE OF MANAGEMENT: You go back in history in the stock market, for the last three decades, there have been eight times they've cut rates. And it's normally been the first cut. And in 1982, it was the second cut.

So we're looking at a stock market that seems to not be responding in historical sense to cuts in interest rates. And that races a red flag to some of us.

WATERS: I've been noticing what your -- some of your computer models are saying about after a cut today: What -- what does it matter? What happens after that rate cut? And there's some good news, bad news, I guess, in there.

ALLVINE: I think the good news: The rate cut will lower interest rates, will be good for certain sectors of the economy, will add a stimulus to the economy. The stock market is very likely, if it's a half, maybe, or three-quarters, very likely to respond positively. But we look ahead a week or two and we wonder if this is just not just a bear market rally and the stock market is likely to go to lower levels.

And I can tell you later on why we think that.

WATERS: It's price-earnings ratios are still too high.

ALLVINE: Valuations are still out of line with a true market adjustment.

WATERS: OK, so the debate today, as you know, among many of you experts is: How big should this rate cut be? And what does it mean if it's a half-point or three-quarters of a percentage point? Is the Fed going to pander to the stock market? Or is Alan Greenspan going to continue to focus on prices -- on a half-a-percent?

I understand it's now half-a-percent. They just reduced it a half-a-percent.


WATERS: So what does that mean?

ALLVINE: What he's basically saying, he's more concerned about the economy. He is not going to cater to Wall Street. They wanted a three-fourths-of-a-point cut. And I think that really was a good move on his part, because he wants to keep the economy moving. And the stock market is only a secondary consideration to the health of the overall economy.

WATERS: I think Lauren Young up there in New York will disagree with you on that. You were advocating three-quarters of a percentage point, were you not?

LAUREN YOUNG, "SMART MONEY": I was advocating the fact that a lot of people in the market thought it was going to be three-quarters of a percentage point.

WATERS: And why do you think that would have been important today?

YOUNG: Oh, there's no question, Lou, that investors have gotten quite greedy in this market. And they are looking for whatever they can grab onto. It will be interesting to see right now how the market react, because I do think that people are going to be quite angry at the 50-basis-point percentage cut. I think that that's not what they wanted.

And while it's true that the Federal Reserve chairman does have a duty to do his job, the stock market is really hanging onto every single clue that he gives us.

WATERS: Well, you're...

YOUNG: And people want more.

WATERS: You're apparently right about that. The market is dropping like a stone here.

Let's check in with Rhonda Schaffler at the New York Stock Exchange -- Rhonda.


You know, this is not surprising because a lot of traders on this floor said: If the Federal Reserve cut by 50-basis points, this is how the market would react, because there were some hopes that there would be a more aggressive rate cut by the Federal Reserve.

Five minutes before the announcement came out, the Dow was up 40 points, above 10000. At this point, it is down 15 points. The Nasdaq was up nine right before the announcement. It is down 10. What we are starting to see is just the initial statement that's coming from the Federal Reserve, talking about a slowdown and saying excess productive capacity has emerged.

So that is the first headline statement that we got that the market is reacting to -- and the Federal Reserve also saying that the economic situation is something that it will be closely watching, as we would imagine. As we continue to get more commentary, we are going to pass it along to you. What I want to do is point out the commentary that came at last meeting, Lou.

At that time, the Fed said consumer and business confidence has eroded further, exacerbated by rising energy costs. And that continues to drain consumer purchasing power and press on business profit margins. So, as the statement continues to come out, traders will be looking for more clues like this. This is the third cut in less than three months. It is not, however, as aggressive as some of the traders and investors would have liked.

Also, what this does, basically, it calls into question what happens historically to the market going forward. And, usually, the market surges an average of 21 percent in the 12 months after series of rate cuts. There was only one exception to that: back in 1930, around the time of the Great Depression. I also want to point out that the Federal Reserve, while cutting the fed funds, also did cut the discount rate. That is often seen as a symbolic move.

At this point, the markets lower, but holding on to just moderate losses: Dow is down 30. Nasdaq is down 13 -- back down to you, Lou.

WATERS: All right, Rhonda Schaffler, New York Stock Exchange. We are also going to jump over to Nasdaq now. The site there is being monitored by John Metaxas today -- John.

JOHN METAXAS, CNN CORRESPONDENT: Lou -- and we are here on Times Square at street level, with a window out on Times Square. And there is a crowd of people that was gathering over the last 15 minutes or so anticipating the decision. They knew it was coming.

Let me show you a quick picture of the Nasdaq, because a picture tells a thousand words. As you can see, the Nasdaq was up about 10, 12 points just before the announcement. And now we see a sharp drop here. Note that sharp 24-point drop. We're now down 14 points on the day. Prior to this, the Nasdaq had been in positive territory the entire day in a very narrow trading range. So the initial reaction is what was expected: a knee-jerk drop in the market.

Conventional wisdom was that the market would be disappointed with only a 50-basis-point cut. You should bear in mind, however, that just a few minutes now after the rate cut, the market's reaction doesn't mean very much. The market hasn't had very much time to absorb this. And, actually, now you can see a little bit of an uptick from the low that was just made.

What's more important is where the market is at the end of the day, at the end of the week, at the end of the month. It will take some time to really digest what the Fed's action means and what the market is going to do with this. Some traders actually said to me they thought that if the Fed only cut 50 basis points, the disappointment in the market went down, that would be an opportunity to buy stocks at bargain-basement prices.

There are still mixed opinions on the economy. For every pessimist who thinks the recession is going to go on for a long time, there are others who say: Well, you know, unemployment is only close to the 4 percent level. The economy still has strength. With only 4 percent unemployment, that means the job situation is still basically good, even though it's deteriorating. So we still don't all the data on the economy: mixed signals. But the Fed is trying to grease the wheels of the economy with this cut. And it will take time to see whether it takes effect.

And the market will take time to digest it -- back to you folks.

WATERS: All right, John Metaxas at the Nasdaq.

In the statement basing its decision on the weakness of the global economy, the Federal Reserve Board has reduced interest rates by another 50 basis points, down another half-percentage point. And the markets have reacted immediately by dropping the Dow down little more than 21 points now -- Nasdaq also down almost seven points.

Let's check in with Lisa Lighter at the Chicago Board of Trade for some reaction from there -- Lisa. Leiter LISA LEITER, CNN CORRESPONDENT: Well, thanks, Lou.

Well, here in the bond market -- which was expected to sell off on a rate cut of only a half-point -- some traders here were hoping for more -- there was a little bit of knee-jerk selling, but then it seems now that bonds have turned around a little bit and the buying has started to kick in.

Right now we have the 30-year bond up just a couple of ticks right now -- the yield there backing down to 5.28 percent. And that benchmark 10-year note is also rallying right now -- the yield on that, the interest rate there of 4.80 percent. Bond traders here were clearly hoping for a bigger rate cut, some of them were. But they are encouraged by some of the words in this statement that the Fed will be monitoring economic development closely.

And they also cited economic weakness in various places here: the pressures on profit margins in this statement and the backup in inventories; talking about manufacturing output as well.

These are all things that have certainly caused the bond market's attention. Right now, it seems like there is a lot of volatility here. And traders are just trying to figure out exactly what the Fed's next move will be -- back to you, Lou.

WATERS: OK, it's little nutty this afternoon. Lisa Leiter at the Chicago Board of Trade.

Professor, we see Nasdaq and Dow now moving back up. That's evidence of the volatility this afternoon.

You've heard the statement from the Fed. You've seen what the decision is. How do you react?

ALLVINE: I think what Alan Greenspan did today, one-half percentage point, was saying he's more concerned about the economy. Economy fundamentals are pretty strong. We have near record-low of unemployment, 4.2 percent. Last year, it was 3.9 percent. The economy may still be holding together.

He didn't want to go too far, too fast, and cave into Wall Street. And Wall Street is still very pricey. And it creates a real problem for Alan Greenspan and the Federal Reserve Board.

WATERS: How about the argument that over 50 percent of us are involved in the stock market in some way, through our 401(k)s or whatever? Because of the drop in stocks, we feel less wealthy. So we're being cautious. We're not spending as much. And therefore, the Fed must restructure its thinking around the markets because so many of us are in it, that the economy dances to the tune of Wall Street.

Do you disagree with that?

ALLVINE: Definitely. We've gone up to six percent in 1980 to 50 percent holding stocks today. And more and more of us are watching the stock market.

But fundamental is the economy and how the economy is doing. And that's what Greenspan is catering to.

WATERS: And Ms. Young up there in New York, what do you think about that?

YOUNG: Well, I do think that the Federal Reserve is definitely paying attention to what investors want.

There's a lot more volatility in the market today because there's a lot more people buying and selling stocks. That is an important factor that did not exist 20 years ago.

WATERS: So is the -- you don't -- is the stock market an ingredient of the economy, or is it driving the economy?

YOUNG: I think that's a great way of putting it, Lou. That we are important, like one of those basic first three ingredients. Whereas before, it used to be much more further down the food chain.

Investors are making this market volatile. And the Federal Reserve chairman knows that, and he's paying attention to it.

WATERS: Do you agree?

ALLVINE: I think that we need to be cautious. Not do anything to drive the market higher. Let it just move along slowly here.

And I think the move today was right in line with what I had hoped would have happened because the economy fundamentally strong, Lou.

WATERS: What are the bright lights here? What's the optimistic view?

ALLVINE: The optimistic view is we may not even gone into recession. This is the longest economic expansion in history. In the end of this quarter, it will be 10 years long. We may have a one-half or 1 percent GNP growth in the first quarter.

The stock market could -- if it went too high and then imploded upon us, it could cause -- bring down the entire economy. Alan Greenspan best wants to take a very easy stance with regards to stock markets.

WATERS: So how would you -- you're an economist. How would you characterize what's going on? Some call it a soft landing. Some call it a slump. You heard the president of the United States say the economy is "sputtering." What is going on here?

ALLVINE: I mean, the ideal situation is to go from a 5 percent GNP growth in the first half of last year to bring it on down to maybe one-half percent, or just barely any growth.

Take the inflation out of it, we have a very strong economy. Have one of the highest levels of productivity and employment. And we can't push it too much higher.

And so I think just stay the course, and that's what Greenspan is trying to do.

WATERS: And Lauren Young, I'll give you the last word.

YOUNG: I was going to say I think what's really crucial for the market right now is around April 15. Taxes will be finished. And also, we'll be seeing the first wave of corporate earnings from companies for the first quarter. That's when we're really going to have a clear sign if people are back on track, or if we're just kind of slogging around in nowheresville.

WATERS: Thank you both, Lauren Young with "Smart Money" magazine, Professor Fred Allvine with Georgia Tech.

Again, the federal interest rate decision has been made: down one-half percentage point. Markets reacted immediately by going down. You see they're headed back up now, higher than they were before the announcement was made. The Dow Jones industrial average's up 54 points. The Nasdaq up 21 1/2 points.



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