By Martin Wolk Executive business editor
updated 3/15/2004 5:03:18 PM ET 2004-03-15T22:03:18

Financial market sentiment has shifted dramatically over the past 10 days, but the forecast for Tuesday's Federal Reserve meeting remains the same: No change in rates and little change in the central bank's cautiously optimistic outlook.

Major Market Indices

A surprisingly weak employment report March 5 followed by last week's terrorist attack in Madrid have sent stock prices sharply lower as investors fret about the long-term economic outlook. Investors have poured money into the safe haven of Treasury securities, sending long-term interest rates to their lowest levels since last summer.

"There has been a major shift since the February employment report was released," said Lynn Reaser, chief economist for Banc of America Capital Management. "Prior to that point there seemed to be a view that the job market would improve very soon, and since that release there has been a growing skepticism that job growth will pick up within the next few months."

Even if the government had reported strong employment growth for February, most analysts expected Fed policy-makers to leave short-term interest rates at current, four-decade lows at least until midyear. Many economists say the Fed would like to see steady growth of at least 150,000 net new jobs for several months before even considering raising rates.

Instead the economy has added only 60,000 jobs a month on average over the past six months, including just 21,000 last month — well short of the average forecast of 128,000. Now few analysts expect the Fed to tighten before the Nov. 2 elections, and many expect Fed Chairman Alan Greenspan and his colleagues to leave rates where they are until well into 2005.

In fact, Goldman Sachs senior economist Ed McKelvey raised eyebrows last week by suggesting in a note that the Fed might not raise the benchmark overnight lending rate from its current rate of 1 percent until after Chairman Alan Greenspan’s term on the board expires in 2006.

“It’s a legitimate question, given how much slack we believe there is in the economy,” McKelvey said in an interview. He stressed, however, that the brokerage’s analysts believe the most likely scenario is that the Fed will begin tightening in mid-2005.

While there is little drama surrounding the Fed's decision on rates, analysts will be watching closely for any changes in the policy statement that is scheduled to be issued about 2:15 p.m. ET.

Greenspan said in congressional testimony last week that "new job creation is lagging badly" — language that was stronger than the Fed's latest formal statement Jan. 28, which said new hiring "remains subdued." But Greenspan also said he was optimistic hiring would accelerate "before long."

That view is supported by recent surveys and a steady decline in new claims for unemployment benefits but some analysts are concerned that structural changes in the U.S. economy mean job growth will remain sluggish this year.

"Companies have been spending 10 years talking about just-in-time supplies, and now they are going to a just-in-time work force," said David Wyss, chief economist for Standard & Poor's. "It's much more of the virtual corporation out there."

With core consumer inflation just above 1 percent, the Fed has been focused for much of the past year on preventing deflation, an outbreak of falling prices that is considered highly unlikely but potentially devastating.

But recently there have been "huge increases" in commodity prices as well as a surge in home prices, even though the limited supply of new jobs has kept wage pressures muted, said Reaser.

That conflicting data is one reason analysts have been arguing over whether the Fed statement will acknowledge that the likelihood of "an unwelcome fall in inflation" is now equal to the likelihood of an increase in inflation, rather than "almost equal" as the Fed described it in January.

But that is getting into the realm of Fed arcana. The bottom line is that few analysts expect Fed policy-makers to say anything to shake up financial markets, especially when they are probably pleased by the latest drop in long-term interest rates.

"Overall the Fed is unlikely to signal any kind of change tomorrow, but Mr. Greenspan has suggested job growth should accelerate relatively soon, and we believe that will be the case," Reaser said. "Then we will see a rapid reversal in interest rates and future expectations for the Fed."

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