IE 11 is not supported. For an optimal experience visit our site on another browser.

Odds for rate cut rise as war looms

Last week’s report of a sharp drop in employment has raised the odds that the Federal Reserve will lower interest rates again next week in an effort to stimulate the flagging economy.  By Martin Wolk.
/ Source: msnbc.com

Last week’s report of a sharp drop in employment has raised the odds that the Federal Reserve will lower interest rates again next week in an effort to stimulate the flagging economy. But given the possibility that war will begin even before the Fed’s scheduled meeting of policy-makers March 18, it is even more difficult than usual to predict what Chairman Alan Greenspan and his colleagues will do.

Most analysts agree the Fed will shift its policy statement from its current “balanced” stance to reflect growing evidence that the economy slowed dramatically in February. Since November, when the central bank surprised financial markets by slashing its benchmark short-term rate by half a percentage point, to 1.25 percent, the Fed’s official stance has been that “the risks are balanced” with respect to the Fed’s twin goals of economic growth and low inflation.

“They will have to reconsider seriously the balance of risks, said Bob Gay, global strategist for Commerzbank Securities. “It just would not appear correct to say that the risks are still balanced between inflation and growth. The numbers just have not supported that.”

Economists are sharply divided over when and whether the Fed will take the next step and trim the benchmark federal funds rate from its current 1.25 percent level, already the lowest in more than 40 years.

Increasing likelihood of cut
Late Friday Merrill Lynch economists issued a report predicting the Fed will lower rates by a quarter-point at the March 18 meeting of the Federal Open Market Committee and another quarter-point at the panel’s next scheduled meeting May 6. That would bring the rate to 0.75 percent, “the lowest the Fed is likely to go,” said the brief report from economists Kathy Bostjancic and David Rosenberg.

If the Fed needs to stimulate the economy further it then could begin buying intermediate and long-term Treasury securities, the Merrill economists said.

Traders in futures markets, who buy and sell securities based on where they think interest rates are headed, currently estimate there is about a 60 percent chance the Fed will cut rates by a quarter-point March 18, up from about 35 percent last week before the employment report came out, said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co.

Fed may still hold its fire
But he and many economists believe the Fed is likely to wait at least several weeks before acting, both to see more economic data and to see what happens on the ground in Iraq. Crescenzi pointed out that the Fed waited two weeks after allied forces launched their attack against Iraq in the 1991 Gulf War, then cut short-term rates aggressively by a half-percentage point.

“This is a really tough call, but I they’ll probably hold off from doing it because it’s not clear it will change market fundamentals much,” said Diane Swonk, chief economist at Bank One. A sharp drop in oil prices in the opening days of a military campaign could provide all the stimulus the economy needs, she said. “My inclination is they’ll wait a couple weeks and see how the sand settles.’

Ethan Harris, chief economist at Lehman Bros., said that Fed policy-makers have put themselves in an awkward position by maintaining their so-called neutral outlook in their official policy and public statements that carefully avoid “talking down” the economy.

Atlanta Fed President Jack Guynn, a voting member of the Fed’s rate-setting panel, referred to a “stealth recovery” in a speech Feb. 11. “The recovery is real,” he said. “It’s showing up on our radar; we know it’s here — it’s just not as obvious as it usually is.”

Greenspan himself said in congressional testimony Feb. 11 that uncertainty over a possible war was the main factor holding back the economy and that he was “not as yet convinced that stimulus is a desirable policy at this point in time.” Greenspan was referring to fiscal stimulus in the form of large new tax cuts, but additional monetary stimulus still would represent a sharp reversal of the publicly stated positions of policy-makers.

Meanwhile the consensus view of the Blue Chip Economic Indicators forecasting panel has been steadily declining and now calls for 2.6 percent growth in 2003, down from 2.7 percent projected in February and 2.8 percent in January.

Harris predicted the Fed will cut rates sometime between the scheduled March 18 and May 6 meetings. If Greenspan plans to engineer a rate cut next week, central bankers likely will signal their intention by the end of this week through carefully leaked stories in the financial press. So far those stories have not appeared.

Harris was critical of the Fed’s policy over the past several months and said growing evidence of an economic slowdown will make it increasingly difficult for policy-makers to avoid confronting the issue openly.

“They clearly are not being very straight with us, and it’s making their own policy more awkward,” he said. “They need to send a message that they are going to be as aggressive as they have to be. I don’t see any point in pretending everything it fine in the economy. Nobody believes it anyway.”

Short-term interest rates already are at their lowest level in more than 40 years, and 30-year mortgage rates also are at their lowest level in more than 40 years, according to mortgage financing giant Freddie Mac.

The last time the federal funds rate was at or below 1 percent on a sustained basis of more than a few days was in 1958, according to Fed data.