POSTED AT 12:09 AM EDT Wednesday, May 16

So the Fed has cut rates again — now what?

By MATHEW INGRAM Globe and Mail Update

Alan Greenspan's job isn't that hard, really. All the Federal Reserve Board chairman has to do is set the overnight lending rate that the big banks have to pay. Oh yes — and he has to try and figure out whether the economy is slowing or beginning to grow again; whether massive job losses are a crucial sign, or whether they are balanced by a strong GDP and healthy consumer confidence; and whether to try and shock the stock market with a smaller (or larger) than expected rate cut, or stick to what has already been priced into the short-term bond market, for fear of starting a panic.

No wonder the sometime clarinet player and former boyfriend of Objectivist philosopher Ayn Rand likes to do his thinking while soaking in the tub — that way he can't hear the hordes of critics pounding on the door, shouting about how the latest cut was too big, or too small, or how the market crash was all his fault in the first place. Tuesday's 50-basis-point cut in the federal rate is already to some extent old news, and the second guessing has already begun about where the Fed should go from here.

After the cut, for example, both the Dow Jones industrial average and the Nasdaq market jumped sharply higher, but they just as quickly fell back to where they were before the announcement. Any enthusiasm that investors might have felt as a result of the rate cut was erased by several things, including profit-taking — and perhaps the fear that the rate-cut party is finally coming to an end. Once the Fed stops greasing the wheels, of course, the market will be left to focus on corporate earnings, and there is still a lot more gloom in that department than there is light.

In many ways, Mr. Greenspan has had a fairly easy time of it for the past six months or so. With an overwhelming consensus that the U.S. economy was not only sliding southward but picking up speed along the way, the choice was obvious: cut rates, and the faster the better. As a result, the Fed chairman has lowered interest rates faster than at any other time in the 14 years he has been at the helm of the U.S. central bank — including two surprise, between-meeting cuts, which the Federal Reserve Board said only last year it would only employ in the case of extraordinary circumstances.

Now, unfortunately, the U.S. economy is getting close to a turning point and the easing process is coming to an end. But how close the economy is to that point, and what kind of turn it will be, is anybody's guess. Except for Mr. Greenspan — he can't guess, because his actions will help determine the answer. Are the signs of cautious growth, such as consumer spending, a good sign? Or do they, along with other things such as higher energy prices, mean that inflation could once again become a problem?

It may be hard to imagine at this point, but some economists are worried that the Fed's monetary stimulus, combined with the impact of the Bush government's proposed tax cuts, will wind up juicing the economy a little too much. In part, that's because the effect of interest rate cuts doesn't really work its way through the economy for six to eight months, and by that time some analysts expect the U.S. growth engine will be back on track. Far from cutting rates even further, there are those market-watchers who feel that interest rate hikes by the Fed may be needed sooner rather than later.

"We're ballooning money supply very rapidly," Wells Fargo chief economist Sung Won Sohn told CNNfn. "That could be dry powder for inflation later on." The economist said he has seen some "worrisome" signs of inflation lately, such as a drop in productivity and a rise in labour costs. "It's quite possible the Fed will have to turn around and raise rates," he said, in the same way it did in 1994 after a series of rate cuts. Several economists have pointed out that the interest rate on long-term bonds is pricing in a return to inflation next year, something the Fed will be watching.

Whether investors get another cut of 50 basis points, or 25 basis points, or perhaps no move at all at the next meeting in June, the consensus is that the Fed is a lot closer to the end of the rate-cut process than it was a month or two ago — and that means investors are going to stop leaning on Alan Greenspan at some point, and start looking for some evidence that things are getting better in terms of corporate earnings and capital spending. If they don't find any, it could be a tough summer.

E-mail Mathew Ingram

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-- Martin Thompson (mthom1927@aol.com), May 16, 2001