Two new reports showing strong economic growth reinforced fears Friday that the economy is still exceeding the Federal Reserve’s speed limit. That could mean higher interest rates and more roller-coaster days on Wall Street.
In its final look at last year, the Commerce Department reported that the U.S. economy, as measured by the gross domestic product, was growing at a robust 3.8 percent rate as 1996 ended, far above the 2.1 percent pace turned in during the third quarter.
And in more recent data, the government said that new homes were sold at a seasonally adjusted annual rate of 811,000 units in February following an even stronger 817,000-unit pace in January. It marked the first time in nearly 11 years that new homes had been sold above the 800,0000-mark for two consecutive months.
The data on new homes followed a report that sales of existing homes shot up 9 percent in February. That news Thursday triggered a steep plunge on Wall Street as investors grew worried that the economy is growing faster than previously believed and that this will force the Federal Reserve to follow up its Tuesday quarter-point increase in interest rates, the first credit tightening in two years, with several more rate hikes.
The markets were closed for Good Friday. On Thursday, the Dow Jones industrial average tumbled 140.11 to close at 6,740.59.
“The basic message from the new reports is that the economy is growing too fast for comfort,” said Robert Dederick, chief economic consultant at Northern Trust Co. in Chicago.
Many analysts believe the economy finished the first quarter this year growing at around 3.5 percent, far above the 2 percent to 2.5 percent the Federal Reserve has signaled as its target for growth during this stage of the expansion, which entered its seventh year this month.
The Fed’s aim in raising interest rates is to slow demand in interest-sensitive sectors such as housing so that price pressures in the overall economy do not get out of hand.
While financial markets were closed Friday in observance of Good Friday, analysts said more reports showing continued strong growth rather than a slowdown would produce jolts similar to Thursday’s 140.11 drop in the Dow Jones industrial average, eighth-worst point loss on record although a less dramatic 2.04 percent decline in percentage terms.
“All of these numbers are really spooking the markets,” said Norman Robertson, economic adviser to Smithfield Trust Co. of Pittsburgh. “The markets had convinced themselves that the economy was already slowing and the Fed would not have to tighten that much. These numbers raise some very serious questions about those assumptions.”
In addition to the steep plunge in stocks, bond prices took a nosedive as well Thursday, pushing the yield on the bellwether 30-year Treasury bond above the psychological 7 percent barrier. The yield ended the day at 7.08 percent, highest level in six months.
Economists said this rise in long-term interest rates would eventually act to slow housing regardless of what the Fed does to the short-term rates it controls. Thirty-year mortgages dipped as low as 7.56 percent in February, but have been climbing steadily in March to stand at 7.97 percent this week, the highest level in almost a year.
“We had a tremendous winter for home sales, in part because of the mild weather, but there are signs that the market is starting to slip a bit,” said Paul Taylor, senior economist at America’s Community Bankers.
The 3.8 percent final estimate for growth in GDP the economy’s total output of goods and services - was only slightly changed from a 3.9 percent projection made last month.
The strength in the fourth quarter came from a sharp rebound in consumer demand, which rose at a 3.4 percent pace compared with 0.5 percent in the third quarter. Also the country’s trade deficit showed a dramatic improvement, but this is expected to be short-lived. The deficit in January hit a record high.
Even with the upturn in growth in the fourth quarter, inflation did not worsen. A price gauge tied to the GDP rose at a rate of 1.9 percent in the fourth quarter, best showing in more than four years.
For all of 1996, the GDP increased 2.4 percent following growth of just 2 percent in 1995 and 3.5 percent in 1994.