By Neil Irwin
Washington Post Staff Writer
Friday, April 25, 2008
Financial markets are starting to function more normally, banks are raising billions of dollars in capital, and the latest economic figures, while weak, aren't much weaker than had been expected.
Taken together, these signs of stability make for the calmest economic period the nation has experienced in months. Now economists are grappling with whether the crisis will continue to ease, or whether this is merely the eye of the hurricane, with more big problems coming soon.
Yesterday, the Census Bureau said sales of new homes in March fell to their lowest level since the early 1990s, and the Commerce Department said orders for durable goods fell for the third straight month.
Next week will offer some bigger answers. On Wednesday, the government will report on the gross domestic product in the first quarter, and on Friday it will issue figures on the job market. A number of other important economic indicators are also scheduled to be released.
The Federal Reserve will hold a policy-making meeting Tuesday and Wednesday. With signs of stability, the Fed is expected to cut interest rates only slightly, if at all, a shift from its large cuts through the first three months of 2008.
"We're going to find out whether or not we fell into recession, how severe it's going to be, and how the Fed is dealing with it," said Richard Yamarone, chief economist of Argus Research. "This is going to be a huge week."
Financial markets remain fragile, as does the outlook for the overall economy, in the view of Fed leaders. That means that they will remain ready to cut rates again if the crisis in financial markets returns or if the economy appears to be falling into a deep recession, rather than the mild one implied by economic data of recent weeks.
But if conditions remain comparatively stable, as they have this month, then the Fed would be reluctant to cut the federal funds rate to less than 2 percent. It is currently 2.25 percent. Yesterday, prices on options markets indicated there is a 1-in-4 chance that the Fed will not cut that rate further next week, a 68 percent chance that it will cut that rate by a quarter percentage point and a small chance of a sharper rate cut.
"You don't want to cut much more," said Dean Croushore, an economist at the University of Richmond who wrote a textbook with Fed Chairman Ben S. Bernanke. "It is time to think about the future. And the little upticks in some of the economic data we've had suggest that the recession will be not too deep."
There have been several periods of calm in the last nine months -- in October and early February, for example -- but each gave way to more tumult. In the view of both private economists and Fed leaders, financial markets remain susceptible to hard-to-predict problems in the months to come, which could worsen the economic outlook in a vicious cycle.
"The problems afflicting our financial markets are indeed long in the making," Kevin M. Warsh, a Fed governor, said in a speech last week. "Correspondingly, the curative process is unlikely to be swift or smooth."
There have been signs of modest improvement. The yield on two-year Treasury bonds has risen sharply, to 2.35 percent yesterday from 1.6 percent at the end of March, reflecting that investors' money is not gushing into ultra-safe investments with the same eagerness. Markets for mortgage-backed bonds, corporate debt and other forms of credit, while still troubled, are functioning more normally than they had in March.
The stock market is up for the month, including an increase of just over half a percent yesterday, as measured by the Standard & Poor's 500-stock index. A separate index of stock market volatility has dropped to its lowest level since December.
There are still significant problems in the financial markets. Notably, the London interbank offered rate, or Libor, has been rising because of strains on European banks. Many U.S. loans, including adjustable-rate mortgages and business debt, are tied to Libor, leading to higher interest rates for some Americans despite Fed rate cuts.
"We're out of intensive care, but we're still in serious condition," Yamarone said.
The Fed has tried to attack the problem of elevated Libor with targeted moves, as have other foreign central banks, though the situation would offer a reason to cut interest rates next week.
As for the broader economy, the impacts of previous Fed rate cuts are only starting to ripple into Americans' pockets. And government stimulus checks will be mailed starting next month, which economists expect to provide a cushion for growth.
"We're not looking at a deep recession as measured by GDP," said Mickey Levy, chief economist of Bank of America. "Where it will be felt deeply is in housing and finance."