Markets Plummet Drop Driven By Fear That Interest Rate Cut Won’t Materialize
Financial markets tumbled Monday as investors worried the budget stalemate between Congress and President Clinton will mean no holiday interest-rate cut from the Federal Reserve.
The Dow Jones industrial average closed 101.52 points lower at 5,075.21, the biggest drop in points since the index plunged 120.31 points on Nov. 15, 1991. But with the market near a record high, the steep slide represented only a 1.96 percent decline.
Republicans were quick to blame Clinton.
“I call this the Clinton crash. This is what Clinton has done to the markets because he refuses to balance the budget,” said House Majority Whip Tom DeLay, R-Texas.
At the White House, press secretary Mike McCurry would not comment on what he called “short-term fluctuations of the market.” He insisted the president remained committed to “a balanced budget which will keep long-term interest rates low.”
The stock market had been soaring to all-time highs on investors’ belief that good news on inflation and a weakening U.S. economy would translate into interest-rate relief at year’s end.
The Fed’s interest-setting Federal Open Market Committee holds its final 1995 meeting today, and many analysts had forecast the central bank would cut a key rate by at least a quarter-point.
Such a move would be reflected immediately in lower lending costs for consumers and small businesses.
But analysts said markets are now pessimistic, believing the Fed will not change interest rates when the budget talks have broken down and the federal government has partially closed for a second time.
“The markets had been basing these huge rallies in stocks and bonds on the expectations of a Christmas present in the form of a balanced budget deal, and they got the opposite over the weekend in the form of sniping from both sides and no deal,” said economist David Jones.
The markets fear Fed policy makers will be prevented from making a rate cut because of uncertainty over whether Washington will produce a balanced budget. Some suggested that if the market continues to plunge, that might be enough to prod budget negotiators.
“In the past, it has often taken a whack from the financial markets to sober up Washington,” said Allen Sinai, chief global economist at Lehman Brothers in New York. “It is a question of the damage from financial market troubles spreading to the economy and hurting the election-year chances of the administration and Congress.”
After raising interest rates seven times through February 1995, the central bank switched course in July and cut the federal funds rate, the interest banks charge each other on overnight loans, by a quarter point to 5.75 percent.
But it has left policy unchanged since then.
Some economists said that even with the budget stalemate, the central bank may still shave interest rates by a quarter-point today, given statistics that show economic growth has slowed markedly in the year’s final three months.
“If the Fed doesn’t do anything, then financial markets are going to send long-rates back up and that will significantly increase the risks of stagnation or a recession in 1996,” said Lawrence Chimerine, chief economist at the Economic Strategy Institute in Washington.
Democrats on the congressional Joint Economic Committee agreed.
“The Fed went too far and too fast when it doubled short-term interest rates between February 1994 and February 1995, and we’re still suffering the consequences - the economy has been sputtering since last spring,” said the panel’s top Democrat, Rep. Pete Stark.
If the central bank does trim rates by 0.25 percentage point, analysts said commercial banks would likely cut their prime lending rate, the benchmark for many consumer and business loans, from 8.75 percent down to 8.50 percent.
But Lyle Gramley, an economic consultant with the Mortgage Bankers of America and former Fed governor, expects the Fed to do nothing because worries about economic weakness are overblown.
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