Markets Seem to Know Something the Fed Doesn't: Caroline Baum
By Caroline Baum
New York, Aug. 23 (Bloomberg) -- If the Beltway Boys and
Girls can get enough mileage out of George W. Bush's cocaine
thing for two Sunday morning talk-show cycles, then I can ask my
readers to endure yet one more column on the Federal Reserve.
Everyone from Wall Street to Main Street to Old County Road
knows that the Fed is going to raise interest rates tomorrow.
They are also under the impression that it will be the last
intrusion from the Fed for the rest of the year.
If not, how else can one explain the recent rally in stocks
and bonds when banks' bedrock cost of funds -- the overnight
federal funds rate -- is expected to climb? The Dow Jones
Industrial Average set an all-time high today, bringing the year-
to-date gains to 23 percent.
The finality assumed by the markets is somewhat curious,
considering that the Fed doesn't know itself about what it will
do. The Fed was leaning towards tightening for the better part of
two years before it lowered interest rates three times last fall.
What's more, it's not clear what the Fed is hoping to
accomplish. Does the Fed want to slow domestic demand? Raise the
unemployment rate? Pose an impediment to a blazing stock market?
Anchor long-term interest rates at 6 percent?
And what is the Fed using as a policy guide? Labor costs?
Raw materials prices? The foreign exchange value of the dollar?
The consumer price index?
Fed chairman Alan Greenspan has telegraphed mixed messages
recently, vacillating between New-Era productivity prophet and
chronic worrier about the scarcity of labor. His new mantra,
''When we can be preemptive, we should be,'' leaves a lot of room
for interpretation.
Two-Handed Economist
In fact, listening to Greenspan is a lot like listening to
Prozac. One never knows which personality will be in evidence.
Let me be the first to admit that I have no idea whether the
Fed will raise interest rates after tomorrow or not. Nor do I
pretend to have any foresight about the timing of any such move.
Without an understanding of the Fed's goals -- other than to
preempt an acceleration in inflation -- it's hard to predict how
much or how often.
Given all the concern about and preparation for year-end in
an attempt to avert the Year 2000 computer glitch, the Fed would
probably prefer to raise rates now and stand pat during the
fourth-quarter, rather than aggravate liquidity concerns.
Recognizing the importance of a liquidity lifeline, the Fed
has established a special facility for lending to banks from Oct.
1, 1999 to April 7, 2000, at an interest rate 150 basis points
above the targeted federal funds rate.
Of course, there is already a special liquidity facility for
lending to banks at 50 basis points below the current targeted
funds rate of 5 percent, called the discount window. With visits
to the window carrying a certain stigma -- a possible sign of a
bank having trouble funding itself -- ''the Fed is covering all
bases,'' says Ward McCarthy, economist and managing director at
Stone & McCarthy Research Associates in Princeton, N.J. ''The Fed
is taking extraordinary measures for what is perceived to be an
extraordinary circumstance.''
Flying Blind
But back to our main narrative. Without a policy guide or
policy rule, Greenspan is essentially ''flying by the seat of his
pants,'' according to the Wall Street Journal's July 29 Review
and Outlook. The Journal's editorial board worries that without
any registered flight plan, Mr. Greenspan's successor may be less
successful at seat-of-the-pants steerage.
Why am I boring you with everything I don't know? Because
there is something I do know. If the Fed's goal is to slow
economic growth from 4 percent to 2.5-3 percent -- and that's
still a big if -- then it's going to take more than the 25 basis
points in June and the expected 25 basis points tomorrow.
''The idea that 50 basis points is going to make any
difference to this economy is a pipe dream,'' says a London hedge
fund manager.
Welcome to Harry Hope's saloon.
Taut as a Drum
Because Greenspan has been so fuzzy on this issue of what he
is trying to achieve (except be preemptive when he can), it's
tough to predict a course of action.
''The Fed is not real confident that the economy can
continue to do what it's been doing without inflationary
ramifications,'' McCarthy says. ''You can't preclude them
tightening again before year-end, even with Y2K, if domestic
demand doesn't slow and the labor market gets any tighter.''
On that score, the labor market is about as tight as it can
get. At 281,250, the four-week moving average of initial
unemployment claims stands at a 26-year low, a sign of
''increased hoarding of employees,'' according to John Youngdahl,
economist at Goldman, Sachs & Co.
In fact, every measures of labor utilization is flashing a
warning sign: from jobless claims to consumers' perceptions of
job availability to broad measures of labor under-utilization,
according to Youngdahl.
Of course, if too many people working doesn't cause
inflation, then the labor market indicators are inadequate.
That's one reason why any forecast for what the Fed will do
six weeks or six months today is ridiculous.
Number Bingo
After seeing its model fail for so many years, ''Even the
Fed even admits they're in monitoring mode,'' offers Dave
Seiders, chief economist at the National Association of Home
Builders.
Policy-makers' reaction to the April consumer price index
was telling. After months of only good inflation news, a 0.7
percent increase in the CPI caused Fed rhetoric to reverse
course. New York Fed President William McDonough took one look at
the number and said there was a ''low chance'' that the increase
was a ''one time event.''
The 0.7 percent increase in the April CPI was followed by
back-to-back unchanged readings in May and June, a feat that
occurred last in 1962.
''We have price stability now,'' McDonough declared after
the release of the May CPI. ''Companies can't get away with
raising prices.''
The Fed is only as confident as the last inflation report.
If the next two CPI reports show an increase of 0.3 percent, as
did July's, and it can't be explained away by Labor Department
chatmeister Pat Jackman, the Fed will raise interest rates again,
Y2K or not. Period. End story.
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U.S. Economy: Numbers Show More Growth, Rate Increase (Update1)
By John Cranford
U.S. Economy: Numbers Show More Growth, Rate Increase (Update1)
(Adds closing markets in 6th, 7th paragraphs.)
Washington, Aug. 23 (Bloomberg) -- Federal Reserve Chairman
Alan Greenspan offered a clue last month to what he and his
central bank colleagues will do when they meet tomorrow: Watch
the numbers, he said.
The statistics show U.S. job growth accelerated in July and
hourly wages grew at the fastest pace in six months. Industrial
production posted a sixth straight monthly increase in July and
factories added workers for the first time in 11 months. Home
sales picked up in June and auto sales in July, even as market
interest rates were rising.
That's why most investors expect central bankers to raise
the overnight bank lending rate by a quarter point again tomorrow
to keep the economy from overheating and sparking an inflationary
increase that would be more costly to stop later. ''It's less
what Greenspan said than the numbers that have come in,'' said
Lyle Gramley, a former Fed governor and now a consulting
economist for the Mortgage Bankers Association of America.
Investors and analysts now are asking: If there's a rate
increase tomorrow, will the Fed adopt a so-called bias that
suggests future increases are possible? Or will it take a neutral
stance, as it did when it raised the overnight bank rate in June?
''There are different degrees of urgency'' among Open Market
Committee members, said Neal Soss, chief economist at Credit
Suisse First Boston Corp. in New York. One reason is inflation
hasn't accelerated yet, even as unemployment has fallen to its
lowest point in a decade -- contradicting long-held economic
theory. ''It's hard to know what you're doing when the economy
doesn't act in ways that you're familiar with,'' Soss said.
'A Close Call'
Bonds were little changed on expectations the Fed won't
follow a rate increase tomorrow with another anytime soon. The
Treasury's benchmark 30-year bond rose 3/32 point, pushing down
its yield a basis point to 5.98 percent, about where it was
immediately following the last Fed action June 30.
Stocks surged for a second day also on interest rate
optimism. The Dow Jones Industrial Average rose 199 points, or
1.8 percent, to close at a record 11299.76. The Nasdaq Composite
Index climbed 71 points, or 2.7 percent, to close at 2719.70.
Because of the uncertain economy, a few analysts aren't
forecasting a rate increase tomorrow. ''It's a close call,'' said
Gramley, who detects signs of a slowdown in housing, consumer
spending and business investment. Instead of an increase
tomorrow, he expects a warning signal in the form of an announced
bias in favor of higher rates down the road if the inflation
threat persists.
What Greenspan said in July was that he and fellow policy-
makers were prepared -- even after raising interest rates in June
-- to do so again if the economy didn't slow soon.
''If new data suggest it is likely that the pace of cost and
price increases will be picking up, the Federal Reserve will have
to act promptly and forcefully so as to preclude imbalances from
arising that would only require a more disruptive adjustment
later.'' Greenspan told Congress in his twice-yearly economic
outlook.
Picking Up Speed
An increase of 310,000 jobs in July on top of 273,000 a
month earlier is just the sort of number that Greenspan was
warning about. So is a 0.5 percent increase in average hourly
earnings last month, following June's 0.4 percent gain. Analysts
surveyed by Bloomberg News forecast a drop in the unemployment
rate for August to 4.2 percent -- matching the three-decade low
reached earlier this year.
Moreover, economists expect the economy to pick up speed in
the second half of this year after slowing in the second quarter,
according to a survey of economists by the Philadelphia Federal
Reserve Bank.
Gross domestic product is likely to expand at a 3.3 percent
annual rate in the third quarter and a 3 percent pace in the
fourth quarter, the 37 forecasters surveyed by the Philadelphia
Fed said. By comparison, the economy grew at 2.3 percent annual
rate in the second quarter, according to a first estimate from
the Commerce Department.
Growth Overseas
Growth in previously weak overseas economies gives the Fed
yet another reason for apprehension. ''When we combine strong
domestic demand with a pickup in demand from recovering economies
abroad, the risk of inflationary pressures begins to build,''
said Robert Parry, president of Fed Bank of San Francisco in a
speech two weeks ago.
Still, measured inflation is tame. The consumer price index
has risen at a 2.4 percent annual rate so far this year. While
that's faster than in the last two years, it's still the third
slowest pace since 1986, when the CPI rose at a 1.1 percent clip.
In 1998 and 1997, the CPI rose 1.6 percent and 1.7 percent.
With inflation at that level, Fed policy-makers are unlikely
to see a need to move aggressively to slow growth. ''Whichever
way we move, it's very unlikely to be very much,'' said William
Poole, president of the Fed Bank of St. Louis, in an interview
with Bloomberg News earlier this month.
Last Fed Move
A Fed interest-rate increase tomorrow would be the second in
less than two months and the first back-to-back increase since
April and May 1994.
On June 30, the Open Market Committee raised the overnight
interest rate for loans between banks by a quarter point to 5
percent. That was the first increase in more than two years and
followed a series of three cuts in the overnight rate last year
after Russia defaulted on its debt and devalued the ruble, which
caused what Greenspan described as ''a seizing-up of financial
markets that threatened to disrupt economic activity
significantly.''
The Open Market Committee on June 30 also adopted a neutral
stance toward future rate increases, which was widely interpreted
as a signal further rate increases weren't in the offing. The
implied yield on the September federal funds futures contract,
tied directly to expected changes in the overnight bank rate,
fell from 5.20 percent the day before the last FOMC meeting to
5.08 percent on July 20.
Then came Greenspan's comments to Congress and the
succession of economic reports that underscored the economy's
resilience. The September futures contract had an implied yield
of 5.23 percent today, suggesting little doubt among investors of
a rate increase tomorrow. |
