Capital on Edge Over Market’s Erratic Pulse

WASHINGTON —  All eyes in the capital will be on Wall Street this morning as Clinton Administration officials and policy-makers at the Federal Reserve Board watch to see if the stock market’s bloody retreat last week will continue in the face of rising interest rates and concerns about a resurgence of inflation.

From President Clinton on down, the Administration’s line has been that stock market volatility should not be considered a major concern in the face of a rapidly improving national economy.

“We are going to have an appropriate public policy for what we think is happening over the long term,” National Economic Council Chairman Robert E. Rubin said Sunday on ABC-TV’s “This Week With David Brinkley.”

“What we are not going to do, because the President won’t let us do it, is react to the short-term fluctuations” of the stock market, Rubin added.

The market posted a loss of 139 points over the week’s holiday-shortened trading, continuing a sharp selloff of more than 300 points that began in earnest in early February. The dive has been attributed to a response to the Fed’s moves to raise interest rates for the first time in five years.

At the Fed, officials have shown no outward signs of believing that they moved too fast or too far to raise rates.

Indeed, just-released minutes of a key February policy meeting show that Chairman Alan Greenspan and other top officials expected a sharp reaction from Wall Street to their actions, especially since Greenspan planned to publicly announce the move, a departure from Fed tradition.

According to the minutes from the Fed’s Open Market Committee, which sets interest rate policy, “they believed that even a slight move at this time was likely to have a particularly strong impact on financial markets,” and “the market effect might be amplified by a contemplated decision to authorize the chairman to announce the policy action. A relatively small move . . . would temper speculative developments in financial markets.”

In fact, the minutes show that the only debate at the central bank has been over whether to raise rates even more quickly than it has. During the meeting, a minority of the members urged a larger rate increase in order to get the action over with quickly and dampen uncertainty in the financial markets about future increases.

Analysts noted that the minutes of the meeting indicate that the Fed was counting on its interest rate increase to deflate an overheated stock market.

Before the Fed’s action, many analysts both inside and outside the central bank were arguing that the stock market was badly overpriced, partly because of the deluge of money into the market from mutual fund investors. Fearing an increase in speculation, Fed officials decided to move to pop Wall Street’s bubble.

So on Feb. 4, the Fed raised its benchmark federal funds rate by a quarter of a percentage point and then followed that with one more quarter-point increase in March.

There is no evidence that the Fed was concerned about the impact of its rate hikes on regions, such as California, that have not yet fully emerged from the recession.

In fact, the minutes of the February meeting show that the policy-makers noted that “a range of indicators suggested that the California economy might be stabilizing, albeit at a depressed level, after an extended period of declining activity.”

The officials also observed that “rebuilding activity following the earthquake in California would stimulate engineering and construction in the Los Angeles area over the quarters ahead.”

Although long-term interest rates have risen by close to one percentage point since they approached record lows late last year, they are still far lower than they were throughout most of the 1980s, when the stock market roared. And so most analysts and investment advisers are urging calm and counseling clients to ride out the market’s bumpy days.

Some analysts said they are wondering how the markets will react to last Friday’s employment report, which offered more evidence that the national recovery is gathering momentum.

The stock market was closed when the report came out, but interest rates surged throughout the day in the bond market.

In the confusing world of the financial markets, good economic news is often bad news for Wall Street, where traders fear that fast growth will bring rising inflation, which erodes the values of stocks and bonds.

But many observers say they believe that the market has overreacted to both the Fed’s actions and the threat of inflation. They note that consumer prices remain relatively stable and that the central bank has only raised its federal funds interest rate by half a percentage point.

“There’s no inflation out there in the real world,” said Irwin Kellner, chief economist of Chemical Bank of New York, who also appeared on the ABC program.