Fed chief: Economy is sound

"U.S. Economy"

03/01/2007

But analysts warn of `bumpy' ride in months ahead


By William Neikirk
Tribune senior correspondent
Published March 1, 2007


WASHINGTON -- A day after a sharp stock market correction roiled financial markets, fears of a deeper plunge subsided Wednesday after Federal Reserve Chairman Ben Bernanke assured Americans the U.S. economy is basically sound.

Other economic analysts echoed Bernanke's calming remarks before the House Budget Committee, where he said financial markets are "working well" and the economy appears likely to grow at a sustained but slower pace this year.

Wall Street rallied with a modest gain of 52.39 points in the Dow Jones industrial average, partly on Bernanke's words and partly on a bounce in other stock exchanges around the world, including Shanghai, where stocks had plunged 8.8 percent Tuesday and triggered the global correction.

Despite these gains, major market indexes came nowhere near recovering the steep losses of Tuesday. Shanghai's stock market had posted a 3.9 percent gain Wednesday. After the Dow Jones industrial average had fallen by 416.02 points on Tuesday, it went up as much as 137 points Wednesday before pulling back.

In fact, economists said they expected a "bumpy" stock market in the months ahead, meaning plenty of volatility deriving from higher uncertainties about housing sales, mortgage debt financed by riskier "subprime" loans, manufacturing and inflation.

In the wake of the correction, analysts said that a different attitude has taken over in financial markets. They said positive stock-price returns might not be as swift or sure while financial risks, such as a still-shaky housing market, will have to be closely monitored.

"We are on notice," said Carl Tannenbaum, an economist at Chicago's LaSalle Bank. "Risks are still present." Risk had been put in the background for months as the stock market steadily rose, bulking up workers' 401(k) savings accounts and creating a strong, rosy momentum.

Neither Tannenbaum nor Diane Swonk, chief economist at Chicago's Mesirow Financial, see a recession on the horizon. Both noted that it was a statement by former Fed chief Alan Greenspan that a recession was possible that contributed to the sharp downturn in the markets on Tuesday. Greenspan did not say that a recession was likely, they said, but his remarks were interpreted that way.

No single `trigger'

Bernanke told the House Budget Committee there was not a single "trigger" for Tuesday's plunge, but he added that there is "no material change in our expectations for the U.S. economy since I last reported to Congress" two weeks ago. In that report, the Fed predicted a moderate expansion in 2007, with no downturn.

The central bank chief said a downward revision in economic growth for the fourth quarter last year from a 3.5 percent annual rate to 2.2 percent "is more consistent with our overall view of the economy than were the original numbers."

Yet that revision, announced by the Commerce Department, meant that the perception of the economy's fourth-quarter performance went from strong to sluggish. New data came in showing that businesses chose to tighten their belts and curtail building of inventories in the fourth quarter.

A separate report showed that new-home sales dropped in January by 16.6 percent from the previous amount, the biggest monthly decline in 13 years. It was a sign that the troubled housing sector has yet to return to stability.

Joel Naroff, a Holland, Pa., economic consultant, said the stock market has had an amazing run, rising 13 percent in seven months, mostly straight up. But he added, "There were a lot of people saying that we were due for a correction. Why do these crazy days happen? They just happen."

Naroff said he sees the economy growing by a sluggish 2 to 2.5 percent this year. "That doesn't mean the economy is falling apart," he said. "That doesn't mean bad times are in front of us. Going forward, I suspect investors may be a little more cautious, and I think correctly cautious."

Swonk said this was not the time for investors to withdraw from the market, but she added, "Fasten your seat belts." Even though the stock market is apt to be more volatile, she said, its basic direction likely will be up.

Downturn possible

But there is a clearer sense now that there are forces in the financial markets that could cause the economy to stall into a recession and lead to a bear market. Greenspan mentioned some of these forces in a speech by satellite to Hong Kong on Monday. The former Fed chief said that corporate profits appear to be softening, and that could lead to a recession.

"It is not a secret that corporate profits are starting to decline a little bit," Tannenbaum said. "That is not new news."

He cited other problems, such as a struggling manufacturing sector and a pullback in business capital investment.

Naroff expressed concern about the housing sector and questioned Bernanke's recent statements that this sector shows signs of stabilizing.

"Bernanke says it is stabilizing, but then we get a huge decline in housing sales," Naroff said. "What does he mean when he says it is stabilizing? Nobody knows what this man means."

Greenspan's statement that a recession is possible appeared to pit his views against Bernanke, who has said he does not see a recession in sight. Greenspan was quoted Wednesday as saying that he was not commenting on federal monetary policy, only analyzing economic conditions as he did before he ran the central bank.

But Greenspan's remarks drew some fire. After the market closed on Tuesday, Brian Bethune, an economist at Global Insight, a Boston economic consulting firm, said Greenspan had crossed over the line.

"He should know better," Bethune said. "He was the one who was famous for dancing around the bus and being circuitous and not very clear. Now he's done the opposite ... Why doesn't he go play golf in Hawaii? He's retired. He doesn't have any hobbies, other than giving speeches around the world."

David Wyss, chief economist at Standard & Poor's, a credit-rating firm, added: "His comments about a possible recession increased people's worries and made them more likely to react."