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June 23, 2003 |
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Fed's Rate Decision May Pose By MICHAEL R. SESIT When U.S. stock markets rally, the world usually rallies, too. In the months ahead, though, that seems far less certain. Investors around the globe will focus on whether the Federal Reserve cuts U.S. interest rates -- and by how much -- on Wednesday. Many expect the Federal Open Market Committee to ease the benchmark federal-funds rate of 1.25% either by one-quarter or one-half percentage point. The U.S. market has factored in a cut of 0.25-percentage point, analysts say, but a 0.50-percentage point cut could give U.S. stocks a well-timed boost, fueling a rally that has seen the Dow Jones Industrial Average rise 22% since mid-March. The big concern for Europeans is that if the Fed cuts rates, the gap between U.S. and European interest-rate levels will increase, further weakening the dollar and strengthening the euro, which makes European exports more expensive on international markets. In that case, the effect of a stronger euro could overwhelm the short-term boost a recovering U.S. economy -- and rallying Wall Street -- could offer Europe. Already, analysts say, European stocks look like a risky bet; their riskiness likely will increase in the months ahead if the Fed cuts rates. The very fact that the Fed is easing again will send a strong message to the U.S. stock and bond markets that it wants to ensure U.S. economic growth has firmly taken hold before it raises interest rates. "I expect the FOMC to issue a statement that sustains market expectations that the Fed will keep the liquidity spigot open" until a solid expansion is under way, says Alan Levenson, chief economist at T. Rowe Price Associates in Baltimore. European and Asian markets, which also have rallied during the past three months, could benefit from that stance in the long term, if lower interest rates ensure the U.S. resurgence takes hold and spreads recovery around the world. "Traditionally when the Fed steps on the gas, we all get pulled along," says Rick Lacaille, chief investment officer of the United Kingdom unit of State Street Global Advisors in London. But he says growth and markets in the 12-nation euro zone are restrained because the European Central Bank has been slower to cut rates and because of the strong euro. "If the currency were not a problem, stronger U.S. growth would help Europe," he says. "But it would have to be awfully strong growth to overcome the strength of the euro." Though it has backed off a bit during the past few days, the euro has been on a long-term tear. From about $1.11 in late April, the currency rose to a record $1.1932 on May 27. On Friday, it stood at $1.1607, still 11% higher than when it began the year and 30% higher than the start of 2002. Europe has to cut interest rates further, says John Ip, an economist at Morley Fund Management in London. Growth is slow; inflation is decelerating rapidly; and European earnings will disappoint. "If the Fed cuts and the dollar falls, the euro goes up and European exports just tank," he says. "You can forget about Germany." In Asia, meanwhile, a U.S. economic boost could help China and the smaller economies, and support their stock markets. A weaker dollar could make exports from these countries more competitive because many of them directly or indirectly peg their currencies to the dollar. But analysts say China is becoming an ever-increasing influence on these smaller countries, which could lessen the direct impact of a U.S. recovery. Money managers say the future of Japan's stock market rests more on the outcome of the political debate in that country on how to solve the country's longstanding banking crisis than on U.S. stimulus, money managers say. Since mid-March, measured in dollars, Morgan Stanley Capital International's Europe index has rallied 30%, its World index has jumped 25% and the MSCI Japan index climbed 13%. In local currency terms -- or after the effect of the weak dollar has been removed -- the rallies have been less impressive. Since the start of the year, the MCSI Europe is up 5.8% and the MSCI Japan is up 3.3%, compared with a rise of 13% for the Standard & Poor's 500 index in the U.S. The Fed's decision will tell investors and business executives a lot about what the U.S. central bank thinks about the strength of the nascent U.S. economic recovery and inflation -- or more specifically the threat of deflation, or falling prices. "Even though we are all looking at the same data as the Fed, the policy response is still a wild card," says John Normand, a strategist at J.P. Morgan in London. "And that policy decision by the Fed will drive stock and bond markets for the next several months." Most analysts doubt Federal Reserve Chairman Alan Greenspan and his fellow policy makers will leave the federal-funds rate unchanged. "Since early May, Chairman Greenspan and other Fed officials have talked openly about the desirability of 'taking out insurance' against the risk of deflation," says Nicholas P. Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati. This jawboning "convinced investors that the Fed would ease at the upcoming meeting and that it would not raise interest rates until well after recovery was entrenched," he adds. If the Fed were to leave rates unchanged, "the stock market would sell off, big time," Mr. Sargen says. But as long as the Fed lowers rates, the cut will reinforce the point "that in terms of proactive policy, the U.S. stands way ahead of its European or Asian, specifically Japanese, counterparts," says Matthew Merritt, a global equity strategist at Citigroup Smith Barney in London. "That says clearly if there is going to be a pickup later this year, it is implausible that the U.S. won't be the leader." A rate cut, though, isn't without risk for the U.S. stock market as well, analysts caution. A half-point cut, while expected by many to give the U.S. stock market a boost, could backfire if the market concludes the Fed thinks the U.S. economy is in worse shape than it has been willing to acknowledge so far. Friday's Market Activity Stocks ended mixed after a host of forces conspired to halt a blue-chip advance led by two Generals. General Motors gained 52 cents, or 1.4%, to $38.59, after the auto maker's announcement of steps to improve its finances1. Prudential upgraded the stock to buy from sell and boosted its price target to $45 from $29, saying GM's earnings likely will get stronger by 2005. General Electric rose 15 cents, or 0.5%, to 30.01, after the conglomerate backed both its second-quarter earnings target2 of between 37 cents and 39 cents a share, and its full-year estimate of $1.55 to $1.70 a share -- one session after Wall Street firms lowered their 2003 earnings views on the company. After a 97-point advance earlier in the session, the Dow industrials retreated to finish up just 21.22 points, or 0.2%, at 9200.75, and finished the week higher by 83.63 points, or 0.9%. Several disappointing profit reports and outlooks took a toll, with Solectron down 68 cents, or 16%, to 3.71, after the electronics-manufacturing services company posted a fiscal third-quarter loss of $3.74 a share, compared with a loss of 35 cents a share a year ago. Standard & Poor's placed the company's debt ratings on credit watch with negative implications. Halliburton slid 1.27, or 5.2%, to 23.16, after the energy-services and construction firm slashed its second-quarter earnings goal3, blaming mounting costs of a delayed offshore-drilling project in Brazil. Several home builders buckled, with KB Home down 5.70, or 8.1%, to 64.25, as analysts questioned the company's rationale for issuing a "conservative" 2003 earnings estimate after beating Wall Street's second-quarter earnings estimate by 18.3%. Dow-industrial component Procter & Gamble edged up 82 cents, or 0.9%, to 91.23, after saying it hopes to resume paying dividends to shareholders in the later part of 2005. California utility PG&E rose 2.11, or 11%, to 21.51, after a unit agreed in principle to a $12 billion reorganization plan. -- Cynthia Schreiber contributed to this article. Write to Michael R. Sesit at michael.sesit@wsj.com4
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