Expectations Grow for More Fed Rate Cuts
Saturday August 4, 7:22 am Eastern Time
By Marjorie Olster
NEW YORK (Reuters) - With little sign the U.S. economy is poised to rebound, expectations are rising on Wall Street that an anticipated Federal Reserve rate cut later this month will not be the last one this year.
At the same time, the next big debate is starting to percolate in U.S. markets over how long the central bank will hold rates down once they reach a trough later in the year.
Markets are already betting with certainty that the Fed will lower its key short-term borrowing rate, the 3.75 percent federal funds rate, to 3.50 percent when it next meets on August 21.
Fed funds futures contracts, a gauge of bond market interest rate expectations, were on Wednesday pricing in a 100 percent chance for the small August rate cut and about a 50 percent chance of another quarter-point reduction by November.
That is a sizable shift from the end of June, just after the last Fed rate cut, when markets saw less than a 50 percent chance of one more quarter-point cut for the rest of the year.
``I think what's led to that shift is just the weakness in the economic numbers -- not only in second-quarter GDP but preliminary reports on July suggest that economic activity is weaker in the third quarter than the second quarter,'' said John Ryding, senior economist at Bear Stearns in New York.
Influential Fed Chairman Alan Greenspan also had a hand in driving up expectations with his testimony to Congress in late July that there was still a risk of the economy weakening beyond what was currently anticipated.
Joe Lavorgna, senior U.S. economist at Deutsche Banc Alex.Brown, said Greenspan's testimony was the key factor driving the shift in market rate expectations.
``The Fed is concerned about growth and they've got the luxury of overshooting on rate cuts because inflation pressures are moderating,'' Lavorgna said
NO SIGNS OF PICKUP
The Fed has already cut interest rates six times this year in a hurried campaign to keep the economy from slipping into recession. So far they have been successful, keeping growth rates at small positive levels.
The economy turned in its weakest performance in eight years in the April-June quarter, with gross domestic product growing at an anemic 0.7 percent annual rate.
The National Association of Purchasing Management on Wednesday released its index of U.S. manufacturing activity in July, one of the first major measures of third-quarter performance, and it declined again.
The NAPM report dashed hopes that the sector would show signs of clawing out of its year-long slump any time soon.
``I think the problems we are experiencing are much deeper than anyone really imagined they were,'' said Norbert Ore, chairman of NAPM's business survey committee.
July sales of new cars and trucks also fell, in another sign of persistent economic weakness. Economists have been pinning hopes for a recovery on consumer spending.
HOW LOW FOR HOW LONG?
An even bigger Fed debate is brewing in the markets, not just over how low rates will go, but over how long they will stay low.
Eurodollar futures, another barometer of rate expectations, are showing the markets expect interest rates to rise by a full percentage point next year. But after seeing the GDP numbers last Friday, traders scaled back their predictions to reflect a slower pace of rate hikes.
According to Deutsche Banc, the average period between the end of a rate-cutting cycle and the beginning of a rate-hiking cycle has been nine months since Greenspan took over the Fed in 1987.
But the Fed waited 17 months from its final rate cut in Sept. 1992 until it began raising rates again in Feb. 1994.
``Where I think the market is wrong-footed is not just in the decline in interest rates but in how quickly the Fed is expected to reverse that,'' said Ryding.
Lavorgna does not expect to see rates move higher as long as unemployment is rising. He predicts the jobless rate will peak above 5.0 percent around the middle of next year.
``The earliest the Fed would raise rates is the latter half of next year,'' Lavorgna said. ``The Greenspan Fed does not raise rates with the unemployment rate rising and we think it will be rising until the middle of next year.'' |
