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Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: John Pitera who wrote (4146)	6/25/2001 12:00:20 PM
From: John Pitera	Respond to of 33421

A Good piece from Briefing.............25 or 50 bp The question gripping the market is no longer if the FOMC eases on June 27, but by how much. The column below lays out the rationale for both a 25 and 50 bp ease. It's a close call with market expectations apt to swing before the FOMC meeting just a week away. The July funds future contract currently prices in 44% odds for a 50 bp move from 48% earlier in the day. The indicator has proved quite reliable with 50/50 the breakeven mark. We're siding with a smaller 25 bp ease but expect the easing to continue to a low 3% - 3.25% funds rate trough. 50 bp The easier call is for another 50 bp. The FOMC has used 50 bp sizes since the easing cycle began at the start of the year. But more to the point, the economy hasn't shown any improvement arguing for another 50 bp and then more until the sought upturn is seen. There is obviously a risk of overextending the ease but the Fed notes little worry with inflation or the pace of ease to date. Back to back payroll declines tell the same story as the 43% annual rise in returning unemployment claimants. Companies are laying off workers as the downturn leaves no net hiring. And the layoff announcements worsen with the continued weak reports on earnings and profits. The eighth consecutive decline in industrial production and the lowest capacity utilization rate since 1983 was enough to swing the 25/50 bp vote at a few major investment houses. The long eight week period to the following FOMC meeting on August 21 adds power to the 50 bp argument. 25 bp The call for just 25 bp bucks the trend but relies chiefly on the significant stimulus in the Fed pipeline and the impending fiscal stimulus. The Fed has eased 250 bp (38%) in just the first 4 1/2 months of the year. The economic effect is not immediate. Most economists put a 6 to 18 month lag on the relationship between policy adjustment and economic growth. So even an optimistic view expects little (if any) recognizable economic effect given the 5 1/2 month period since the easing began. The monetary stimulus begins to arrive in the coming months as does the $40 bln of tax rebates due by the end of September. Then another $60 bln of immediate fiscal stimulus arrives in fiscal year 2002 (which begins Oct 1) as tax withholdings are adjusted July 1 -- just weeks away. Patience is a tough request to make on an anxious market. Harder still when the recession seems only to deepen. A comparison to the easing of the last recession warrants note. The Savings and Loan collapse left a credit crunch which forced the real funds rates down to a low of -0.50% two long years after the recession had ended. The real funds rate (using the core CPI) stood at 3% at the July 1990 start of recession and 0.9% at the conclusion in March 1991. Non-voting Fed president Broaddus noted yesterday the lack of "leeway" to continue to aggressively ease as the real funds rate now stands at 1.5%. A simpler view notes time itself as a factor not to be ignored. The excesses (business investment, equity prices, lean inventories) of the boom took years to build and require more than a few months to recover from after the pops. The cost side solutions (capital spending, layoffs) take time. The fast-forward policy actions have rushed medication but healing takes time (despite desire). The post-bubble economy is remarkable given the severity of the plunge in investment spending and the manufacturing sector capital investment drives. But at some point you have to slow the fast forward to measure pipeline stimulus rather than just the results spilled out the end. Pre-emptive policy works both ways. Finally, Friday's report that 6 of the Fed district banks sought only a 25 bp cut in the discount rate and one preferred no change suggests a toning down of policy expectations by the Fed banks themselves. While the size of the discount rate adjustment is one made by the Fed Board, the fact that a majority of the 12 regional Fed banks sought a smaller policy ease than the 50 bp delivered is a indication of Fed tone. While we are in the 25 bp camp we do expect the easing to continue. A 3% funds rate trough is quite likely despite the 3.5% low the funds futures market prices in.