By Martin Wolk
msnbc.com
updated 1/28/2004 11:24:25 AM ET 2004-01-28T16:24:25

Despite strong economic growth that helped propel stock prices to a 31-month high Monday, the day of reckoning for interest rates could be receding into the future.

Major Market Indices

As Federal Reserve policy-makers conclude a two-day meeting Wednesday, analysts are sharply divided over when central bankers will begin to raise short-term interest rates from their current historically low levels. Almost certainly there will be no change in policy when the Fed announces the meeting results at about 2:15 p.m. ET, and nearly all major forecasters expect the central bank to stay on the sidelines at least until midyear.

But that is where the consensus ends. Roughly half the analysts contacted in recent surveys expect the Fed to begin raising rates by August, while the other half believe the Fed will leave short-term rates unchanged at current low levels well into 2005 – especially after last month’s disappointing employment figures.

“The economy has been giving off conflicting signals,” said Vince Boberski, senior economist at RBC Dain Rauscher. “Everybody has been digesting the data through the lens of last month’s employment report.”

In fact virtually all the economic signals have been positive except for the critically important employment report, which showed the economy added only 1,000 jobs in December, not the 150,000 many analysts had expected.

Yet the government is expected to release preliminary figures Friday showing the overall economy grew at a robust 4.8 percent rate in the fourth quarter after third-quarter growth of 8.2 percent, the fastest pace in 19 years. Boosted by the lowest mortgage rates in 45 years, the housing industry has just turned in its third straight record year of sales. And new-home construction ended the year with a surprising surge, raising the prospect for another strong year, if not a record.

Still, with no job growth, no inflation and not much fiscal stimulus left in the pipeline, the Fed has little incentive to clamp down on credit by raising rates, said David Rosenberg, chief North American economist at Merrill Lynch.

“Once the Fed starts to tighten, history tells you the most likely outcomes are a soft landing or a recession, and I doubt very highly the Fed wants either of those two outcomes,” he said.

With a key employment report coming up Feb. 6, to be followed the next week by congressional testimony of Fed Chairman Alan Greenspan, the central bank likely will try to avoid stirring financial markets with its comments Wednesday. Most analysts believe the central bank will reiterate its intention to keep rates low for a “considerable period,” although the Fed might adjust the language after Greenspan’s testimony, said Rosenberg.

“Even if they take (the phrase) out I think … the Fed will still find a way to signal to the market that a tightening cycle is going to hinge on a visible turnaround in the inflation picture, and that is most likely going to come from the labor front,” he said.

Doug Duncan, chief economist for the Mortgage Bankers Association, said the employment picture could change significantly after the Feb. 6 report, which will include a revision of employment figures going back two years. Duncan said the revision is likely to show that employment has been growing more strongly than previous reports indicated, and that in turn will raise the odds for a Fed rate hike by August.

While analysts see little chance of a Fed rate hike either this week or for months to come, long-term interest rates have spiked higher on financial markets in recent days. The yield on 10-year Treasury bonds rose to 4.13 percent Monday from 3.93 percent Thursday, an unusually sharp two-session move, said Mary Ann Hurley, a bond trader at D.A. Davidson & Co. in Seattle.

She said bond markets have been roiled by an expected influx of new supply, including a possible unusual sale of 20-year bonds indexed for inflation. The Treasury has not issued securities with more than a 10-year maturity in several years, and investors typically have not been particularly receptive to 20-year securities, she said.

Besides, with the economy showing strength on most fronts, bond investors figure that market interest rates probably have bottomed out, Hurley said.

“It’s tough for the bond market to rally in the face of strong economic news and with supply upcoming,” she said.

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