Wednesday, October 29, 1997

Chaotic market may bring lower interest rates

By Robert A. Rankin / Knight-Ridder Newspapers

WASHINGTON -- The stormy stock market may hold a silver lining for consumers: lower interest rates.

If you are thinking about buying a house or financing some other major purchase by borrowing, the turmoil on Wall Street may shave your financing costs and save you money.

With the market so volatile -- the Dow Industrials plunging 554 points Monday and surging back 333 points Tuesday -- analysts were cautious about drawing firm conclusions about what it all means for the average consumer.

But they do share the conviction that the financial volatility is all but certain to freeze the Federal Reserve Board into inaction. The Fed had been widely expected to begin raising interest rates at its Nov. 12 board meeting, in an effort to head off potential inflation. Now, analysts agree, there is almost no chance that the Fed will do so.

"This makes it highly unlikely that the Fed will raise rates, at least for a few months. We're probably safe on rates until March," said David Wyss, chief economist at Standard & Poor's DRI consultants in Lexington, Mass.

A second source of downward pressure on U.S. interest rates results from the financial turmoil abroad, especially in Southeast Asia. That will slow the U.S. economy by cutting demand for U.S. exports. It also will drive Asian investors into a "flight to quality," which means they'll put more money into safe, sound U.S. bonds. Both trends would push down U.S. lending rates -- not dramatically, but down.

"It is favorable for rates -- if there is a correction," said David Lereah, chief economist for the Mortgage Bankers Association, referring to a prolonged drop in the overall value of U.S. stock prices.

"Right now that's in question," Lereah cautioned, noting Tuesday's rebound.

If U.S. stock prices continue rebounding enough to offset the 9 percent drop since the Dow Jones Industrial Average peaked at 8259 on Aug. 6, this week's turbulence will have had no effect on interest rates, Lereah said.

Even if that happens, many analysts say the sinking Asian economies will combine with the financial volatility not only to check the Fed from raising rates, but also to slow the pace of U.S. economic growth next year.

"The Southeast Asian crisis is not going away very quickly because nobody knows how to stabilize those currencies. And that will weigh on the Fed," said James Annable, chief economist of First National Bank of Chicago.

"They've seen how that can send shivers through the market. It's easy (for the Fed) to raise rates to enhance (its) credibility as an inflation-fighter when the stock market isn't falling 550 points. When that happens though, you focus much more on systemic efforts" and don't rock the boat.

U.S. growth will slow some next year because Asian economies such as Hong Kong, Thailand and Indonesia will purchase fewer U.S.-made goods now that they've been battered.

"Well, that's bad," Annable noted, "but as a matter of fact, we were growing too fast." The combined impact of financial volatility and Southeast Asia's woes should slow the pace of U.S. economic growth by only a little in 1998, however; most forecasters expect an annual growth rate of 2.25 to 2.75 percent next year.

That's still a healthy economy, but one growing more slowly than the 3.75 percent range expected for this year. On Friday, the Commerce Department will report the growth rate for the July-September quarter.

Another hidden benefit for U.S. consumers from all this is that imports such as shoes and apparel from Southeast Asia will be cheaper now, because the U.S. dollar is much stronger against their currencies.

"The dollar will stay stronger than it would have been, and that keeps import prices falling," said Joel Naroff, chief economist for First Union Bank. Even so, U.S. consumers won't notice it much, analysts agreed, because Americans simply don't import much from those countries.

"It's hard to make good news out of a stock-market crash," observed DRI's Wyss, "but the other good news is it doesn't make a heck of a lot of difference to the U.S. economy. People do spend out of (stock-generated) wealth, but not that much, only 3-4 percent at most (of total spending). And a lot of that impact is offset because lower interest rates will boost other forms of economic activity.

"People living on stocks are hurt, people living on borrowed money are helped. And America being what it is, that means a lot more people are helped" by falling interest rates than were hurt by falling stock prices, Wyss said.