FOMC is still on hold But is the Fed's patience wearing thin?
CBS MarketWatch - Tue Mar 31 15:10:18 1998
WASHINGTON (CBS.MW) -- As expected, the Federal Reserve kept
interest rates steady at its regular policy-making meeting Tuesday.
But the Fed's patience must be wearing thin.
Market likes it
Investors, taking the no-action announcement for granted, maintained an
upbeat stance, and the Dow Jones Industrial Average was 73 points higher
at 8855 an hour the news hit the wires at 2:14 pm Eastern.
Analysts were nearly unanimous in predicting that the central bank's
policy-making Federal Open Market Committee wouldn't make a move, but
the consensus was based more on the political landscape than the economic
realities.
Like many firms on Wall Street, the Fed has taken to pre-announcing its
bad news. So far, the Fed's governors haven't slipped any hints that they
will change monetary policy any time soon, even though the economic data
could provide a strong argument for tighter monetary policy. Indeed, the
Fed appeared to be ready to tighten last fall under similar economic
conditions, before the shock waves of Asia swept around the world.
"Domestic demand is as strong as can be," said Mickey Levy, chief
financial economist at NationsBank, on Monday. "One could make the case
that, in order to resume the disinflationary process, the Fed should tighten."
An interest rate hike could come as soon as May 19, Levy said, "By then,
the Fed will have two more months of jobs reports, two more months of
retail sales reports.
"How long can the Fed remain patient?" Levy wondered.
Opposition to tightening
But other economists argue that the Fed should stay out because global
forces are keeping prices low even as the U.S. economy powers toward a
sixth straight quarter of real growth above 3 percent."
U.S. disinflation reflects such long-term fundamentals as the end of the
Cold War, access to cheap labor overseas, technological innovation spurring
productivity gains, a global glut of output, global excess capacity and an
intensely competitive global market," said Philip Braverman, chief economist
at DKB Securities.
Fed Chairman Alan Greenspan told Congress in his Humphrey-Hawkins
testimony in February that the U.S. economy was delicately balanced
between two opposing forces: strong domestic growth and weak demand
from Asia. He said the "storm clouds" from Asia would likely cool off the
U.S. economy by springtime.
It hasn't happened yet, leading some people like Levy, to wonder if Asia
hasn't been overblown. Because job growth is strong, consumers have the
confidence to spend. Because interest rates are low, money goes further.
And because the stock market is booming, wealth seems inexhaustible.
The good times are rolling for the U.S. economy, even as some observers
see trouble ahead. See full story.
The Fed has long subscribed to the argument that the U.S. economy cannot
sustain economic growth above 2.5 percent or so because strong growth
will drive the unemployment rate so low that firms will begin to bid up
wages.
Wage-push inflation
There are signs that wage-push inflation is bubbling as the jobless rate
remains below 5 percent, some economists say. The March employment
report, which will be released Friday morning, will be closely watched for
any signs of inflationary pressures on the wage side.
"The best news on core inflation has already occurred," Levy said. He said
the bond market, which had persistently overestimated inflationary
pressures, has now gone to the other extreme.
"Treasury yields are vulnerable to the market's reassessment of the
magnitude of the Asia turmoil on the U.S. economy and its eventually
realization that low reported inflation is temporary," Levy said.
"Treasuries are more likely to sell off on bad news than rally on good
news," said Sherry Cooper, chief economist at Nesbitt Burns. "The windfall
from lower resource prices now seems to be behind us." Still, in the long
run, Cooper expects the 30-year yield to fall to around 5 percent, a
comfortable level given the low-inflation environment and the reduced
supply of bonds from the Treasury.
The bond market and the rest of the economy will be watching the Fed
governors and the economic data closely throughout the spring for clues
that the hoped for Asian soft landing has arrived. With profit expectations
falling for most companies, low interest rates are the major prop holding up
the market. The next seven weeks will be crucial.
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