WASHINGTON — The Reagan Administration attempted to calm tumultuous financial markets Thursday, even as the stock market fell sharply for the second day in a row and interest rates continued to rise.
Treasury Secretary James A. Baker III called the recent nose dive in the stock and bond markets an "overblown" reaction to inflationary fears and misleading trade statistics. "Conditions do not warrant 'Apocalypse Now' worries or scenarios," he insisted.
Baker also hinted that the Administration, which has supported a stable dollar since February, would tolerate a further decline in the value of the dollar against the West German mark--but not necessarily against other major currencies.
Turmoil in Markets
Baker's comments came amid continuing turmoil in the financial markets:
--Chemical Bank of New York raised its prime lending rate to 9.75% from 9.25%. It was the third such increase in the bench-mark rate in five weeks, and other banks are expected to follow. (Details in Business.)
--The stock market dropped sharply again, with the Dow Jones industrial average falling 57.61 points to 2,355.09 after plummeting a record 95.46 on Wednesday. (Details in Business.)
Separately, the White House, worried that rising interest rates might begin to choke off the five-year-old economic expansion, issued a statement contending that "interest rates are significantly higher than can be justified by current or expected inflation" and predicting that "they are likely to move down in the months ahead."
But investors clearly were not soothed. Within an hour of Baker's remarks, they sent the Dow Jones industrial average, which had been about level until 3 p.m. EDT, plunging 57.61 points.
Interest Rates Rise
Interest rates continued to rise, but at a more moderate pace. The Treasury's key 30-year bond yielded 10.22%, compared to 10.16% last Wednesday.
On Wednesday, the Dow fell a record 95.46 points and long-term interest rates rose above 10% for the first time in nearly two years in response to a government report that the nation's chronic trade gap failed to narrow in August as much as most forecasts had predicted.
"I'm still in my foxhole," said John Sebastian, chief economist at the Clayton Brown & Associates investment firm in Chicago. "We're still reeling from yesterday."
The latest turn of events dramatically illustrated the widening gulf between Washington's economic outlook and perceptions on Wall Street.
Government officials are encouraged by the underlying strength of the U.S. economy, as reflected by the growing number of Americans with jobs and the rebound in manufacturing that is reviving the nation's Midwestern heartland.
But investors are pushing up interest rates apparently out of fear that a new round of inflation, possibly aggravated by a sharp drop in the dollar, is just around the corner. Rising interest rates, which protect against future inflation, have contributed to the stock market's plunge by tempting investors to move their money from stocks to fixed-rate bonds.
Several economists argued that financial markets are likely to settle down in the weeks ahead if new statistics provide fresh evidence that inflation is not heating up and if the Federal Reserve moves to assure investors that it does not want interest rates to rise further.
"The markets are (assuming) that every conceivable thing that can go wrong will go wrong," said Jerry Jordan, chief economist at First Interstate Bank in Los Angeles. "But we think interest rates will fall back down again once it becomes clear that inflation is not going higher and that the real volume of foreign trade is continuing to improve."
Baker Sees Reagan
Baker, after meeting with President Reagan and White House economic adviser Beryl W. Sprinkel, told reporters that recent statements by Fed Chairman Alan S. Greenspan indicate he shares the Administration's belief that interest rates are higher than justified by the inflation outlook.
"In time," Baker said, "investors will begin to take those comments at face value."
So far this year, consumer prices have been rising at a 5% pace, sharply higher than last year's 1.1%. But much of the acceleration has stemmed from the turnaround in oil prices this year after the sharp drop-off in 1986. With oil prices now stabilizing, many analysts say they expect prices to rise at a relatively placid rate under 5% in the months ahead.
One hidden fear that could help account for the recent jump in interest rates, some economists noted, is a modest rise in interest rates in West Germany. Investors worry that Germany's efforts to tighten monetary policy despite little or no inflation there might force the Fed to push up U.S. interest rates as well to prevent the dollar from weakening against the German mark.
Baker Attacks Increase