The economy weakened further last month amid housing and credit market turmoil, with consumers feeling less confident and pulling back spending at shopping malls while output at the nation’s factories fell for the first time since February.
The latest reports on the economy yesterday strengthened the case for the Federal Reserve to cut interest rates at a meeting scheduled for Tuesday to ensure the economy does not slip into recession. The most important underpinning for the economy — consumers — were noticeably undercut by the crisis on Wall Street during August as well as rapidly declining home sales.
Consumer sentiment has fallen to its lowest point in a year, the University of Michigan reported, and retail sales posted a soft 0.3 percent gain last month that was entirely the result of clearance sales at auto dealers, according to the Commerce Department. Outside autos, retail sales plunged by 0.4 percent, driven partly by lower revenues at gas stations because of lower pump prices.
However, with oil rising to new records above $80 per barrel this week, gasoline prices may start rising again, leaving consumers less to spend on other items.
“Retail sales were disappointing,” said David Wyss, chief economist at Standard & Poor’s Corp., while the Fed’s report of a 0.3 percent drop in manufacturing production last month “adds to the fears” of recession that started a week ago when the Labor Department reported a big drop in manufacturing jobs.
The accumulating weakness cannot be ignored by the Fed, he said, which is expected to respond with its first rate cut since 2003.
“Financial markets remain stalled by fear, and liquidity has effectively dried up. Borrowing costs have risen and conditions toughened,” he said. “The Fed must cut next week.”
Like most Fed watchers, Mr. Wyss is expecting the central bank to trim short-term interest rates by a quarter-point and follow up with a second quarter-point cut in October if the tentative signs of economic distress are confirmed.
While the danger of recession has risen, Mr. Wyss said the need for Fed action is equally acute because of the deep freeze in credit and money markets, which has engulfed many borrowers and threatens the solvency of major financial companies and banks like Countrywide Loans and Washington Mutual savings and loan.
“What’s happening now is a classic run on the bank, except that the banks” have been replaced in part by short-term money market funds, “which have become a virtual bank” for many consumers and investors, he said. Some investors have been pulling out of money market funds out of worries that they put their money in subprime mortgage securities or other risky debt instruments, creating what amounts to a modern-day run on the bank like the one that occurred in 1907 and led to the creation of the Federal Reserve system, he said.
“A central bank’s role in fighting bank runs has been well established: Provide adequate liquidity so that the panic does not bring down the solvent banks,” he said. “This principle needs to be extended to the money markets that now support the banking system.”
In an example of how the crunch that started with subprime lenders has the potential to spread to otherwise healthy banks, Britain’s Northern Rock bank experienced a liquidity crisis yesterday and had to receive an emergency cash infusion from the Bank of England after consumers started lining up on the streets to withdraw their savings.
While consumers in the United States generally are feeling more of a vague sense of unease, the response to tightened credit conditions has been sharp in some quarters. Business confidence has plunged and home sales have collapsed in cities like San Francisco — where a majority of buyers rely on jumbo loans that have become hard to get.
“The shock of significantly tighter lending standards has hurt business conditions,” with all the businesses surveyed by Morgan Stanley this month reporting a lot or somewhat more difficulty in getting loans, said Richard Berner, chief economist at the Wall Street investment bank.
The credit crunch comes at a time when more U.S. businesses than ever have fallen into junk-credit status, in part because of the leveraged buyout binge of recent years, according to Standard & Poor’s. That makes many large corporations vulnerable to the sudden distaste for risk among money market funds, European banks and other traditional investors in U.S. corporate debt securities.
While the stock market has sloughed off concerns and improved some in recent days, Mr. Berner said that is due in part to expectations of an aggressive easing by the Fed — a presumption of a half-percentage-point slash in interest rates.
“A rate cut of 50 basis points would be overkill,” said Peter Morici, business professor at the University of Maryland. It would “risk repeating the aggressive and excessive interest rate cutting of 2001, which contributed to the housing bubble and current economic woes.” Just as much good for the economy would be accomplished with a smaller rate cut, he said.