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Fed’s rate decision takes on added importance

Wall Street will focus this week on the Federal Reserve and whether policymakers will raise interest rates an 11th straight time, a move that could cause investors to pull back amid greater uncertainty about economic growth after Katrina.
/ Source: The Associated Press

Wall Street will be focused this week on the Federal Reserve and whether policymakers will raise interest rates an 11th consecutive time, a move that could cause investors to pull back amid greater uncertainty about economic growth in Hurricane Katrina’s aftermath.

But while analysts remain largely split on which direction the Fed will take at its Tuesday meeting, many believe changes to the central bank’s policy language will have a broader impact on the market. With soaring gasoline prices already putting a squeeze on consumer spending, signs that the Fed is more concerned about inflation or the hurricane’s economic toll could send Wall Street tumbling.

John P. Waterman, chief investment officer at Rittenhouse Asset Management, said he thinks the Fed will go ahead with another quarter-point increase — lifting the benchmark rate to 3.75 percent — because the longer-term effect of higher interest rates is beyond the scope of Katrina’s near-term impact.

“Katrina’s impact is big, but short term and more regional,” Waterman said. “I think the Fed is going to say there will be government spending, more than enough to offset the short-term impact. Their primary concern is going to be inflation.”

Up and down? Analysts differ
“I think this is very, very tough for the Fed. There’s also the compassion issue. You run the risk of looking very callous by raising rates,” said Brandeis University economics professor Stephen Cecchetti.

When all the risks are weighed, though, Cecchetti predicts the Fed will nudge rates higher.

Those in the rate-raising camp make this case: From an economic standpoint, inflation is more dangerous now than is the threat of a serious economic slowdown.

Other analysts say the prospects of a downturn are more of a risk. They say the Fed should leave rates alone on Tuesday.

“I think the greater risk is that higher energy prices will cause consumers to pull back, slowing overall economic growth,” said economist Kathleen Camilli, president of Camilli Economics. She is on the side of those who think the Fed will leave rates unchanged at its meeting.

Other analysts feel the Fed needs to leave rates unchanged to bolster consumer confidence and keep lending costs low as the Gulf Coast region rebuilds. And stopping the string of rate hikes would lend to greater clarity about where the economy is headed, Waterman said.

“When the Fed raises rates, it creates a lot of uncertainty about future economic growth,” Waterman said. “Once the market is convinced the Fed is done (hiking rates), you’re going to start seeing a rally. But it could be that this market is just moving sideways for a while.”

Nonetheless, another week of cooling energy prices and light volume kept Wall Street trading in a narrow range as investors absorbed more estimates of Katrina’s impact. Last week, the Dow dropped 36.62, or 0.34 percent; the S&P dropped 3.57, or 0.29 percent and the Nasdaq dropped 15.16, or 0.70 percent.

Housing starts data due out
Aside from the Fed’s announcement, there is little economic data worth noting in the week ahead. The Commerce Department will release the August tally of new housing construction and building permits.

Both are expected to decline slightly, though the numbers will likely track higher in the coming months as reconstruction after Katrina is under way.

On Thursday, the Conference Board will release its index of leading economic indicators for August. The index, which attempts to predict future economic activity, was expected to drop 0.3 percent after a 0.1 percent rise the previous month.

Earnings from FedEx, Circuit City, Morgan Stanley
The market’s obsession with oil and energy will be fed in the week ahead as FedEx Corp., the multinational shipping company, reports its earnings. The company is expected to earn $1.18 per share, up from $1.08 per share, when it reports Thursday morning, but the company’s statements will be closely watched for signs that high gasoline and jet fuel prices are eating into its margins. FedEx shares have fallen 21 percent from their 52-week high of $101.87 on March 7 to close Friday at $80.19.

After disappointing earnings from Best Buy Co. Inc. last week, investors will be closely watching Circuit City Stores Inc., the nation’s No. 2 electronics retailer, as it reports earnings on Tuesday morning.

Circuit City shares have risen 20 percent from a 52-week low of $13.40 on Jan. 12, but are still mired in a relatively narrow trading range as concerns about the company’s long-term prospects persist. Circuit City, which closed Friday at $16.05, is expected to lose 3 cents per share, compared to a 6 cent-per-share loss a year ago.

Shares of Wall Street investment bank Morgan Stanley have yet to recover from the months of uncertainty surrounding the departure of former Chief Executive Phil Purcell, and shares remain 14 percent off their 52-week high of $60.51 on Feb. 14.

The company is expected to earn $1.05 per share when it reports Wednesday morning, up from 78 cents per share in the third quarter of 2004. Morgan Stanley closed Friday at $52.

As always, the Fed’s interest rate decision and policy statement are due to come out at 2:15 p.m. EDT. If the past is any indicator, the markets will likely seesaw for several minutes before a consensus opinion forms and stocks pick a direction.