Economics behind sag in stocks: interest jitters that appear overblown

FOR one traveling on the Continent and here in London this past week, the issue of airport security and the American actions taken against Libya seemed far more riveting than the subject of the United States, or world, economy. But even here last week's sharp reaction in the US stock market was noted, and -- the next day -- felt in markets here.

Any market that runs up as fast as the New York Stock Exchange did over the past two months must have a pause at some point. But this is not a market column. Rather, we need to look at the economic news that seems to have been the catalyst hitting both the stock and bond markets.

Last Wednesday the government announced that the unemployment rate had fallen 0.1 percent in December. It is now at 6.9 percent of the civilian labor force. Perhaps more relevant in that set of statistics, manufacturing employment grew some 30,000, making December the third month during which manufacturing jobs had increased.

It may be too early to assign this growth to the decline in the dollar that began in late September. If the two factors are related, it is more on the basis of expectation. Currency changes usually take two or three quarters to work themselves through the trading system before actual changes in trade flows appear.

Anyhow, on the basis of this decline in unemployment, Henry Kaufman, the chief economist of Salomon Brothers, said it didn't look as if the Fed would be lowering the discount rate a notch.

The decline in joblessness is, of course, good news. But a move of 0.1 percent in a single month has no particular significance. One has to look at a trend over several months to be sure of its meaning. Just as meaningful to an analysis of the economy would be the so-so Christmas selling season, which tends to reinforce the evidence that the consumer has decided to slow down for a while. The latest Conference Board survey of consumer confidence (for December), released last week, showed a slight drop in confidence from the previous month.

If last week's news signals an end to accommodation by the Fed, that would in time be bad news for the economy. And that's what the market reaction was saying. That reaction, however, would appear at least premature.

The Fed has indicated throughout this cycle that it does not want to bring on another recession. It has steered an amazing course between convincing the investment decisionmakers that its fight against inflation is serious and in feeding enough reserves into the economy to keep it growing.

With the rest of the industrialized world still showing weak growth (Germany is probably the strongest right now), and with oil prices still declining and other commodity markets weak, there doesn't seem to be much risk that the Fed is going to allow credit in the US to tighten sufficiently to cause a recession. Moreover, the Fed also has to watch how fast interest rates decline to protect the dollar exchange rate.

There are some signs the dollar has declined about as much as the administration would like. It can't necessarily stop the fall, if there are fundamental reasons for it to decline further. But it must be concerned about interest rates getting too low to continue to attract foreign investment.

The year's first full week, as seen from over here, was confusing. But the market hullabaloo certainly looks like an overreaction to economic news.