Fed Watchers Split Between Half and Quarter-Point Move
Rate Cut Expected; Size Unclear
By John M. Berry
Washington Post Staff Writer
Tuesday, November 6, 2001; Page E01
With the scope of the economic damage done by the Sept. 11 terrorist attacks more starkly clear, Federal Reserve policymakers meeting today are expected to cut interest rates for the ninth time this year.
The attacks delivered a severe shock to the country, its financial markets and its economy, prompting the central bank to cut rates twice in the following three weeks.
Since then, almost all the news about the economy has been bad, as companies have laid off hundreds of thousands of workers, consumer confidence has plunged and manufacturing activity has declined. On Friday, the government reported that the unemployment rate jumped in October by half a percentage point, to 5.4 percent, the largest monthly increase in more than two decades.
In this economic climate, analysts who closely watch the central bank agree that Fed officials will lower their 2.5 percent target for overnight interest rates; the only question is by how much -- a quarter-point or a half-point.
Before the jobless report Friday, a substantial majority of investors had indicated through the pricing of certain futures contracts that they expected a quarter-point cut. Since then, sentiment has swung the other way, with more investors looking for a half-point cut to be announced around 2:15 this afternoon.
At first blush, the severe nature of the jobs report would seem to guarantee such a response by Fed policymakers. But for the officials meeting today, the issues are more complicated than they might seem because of how much the Fed has already done this year and the shrinking room they have to do more.
That the issue isn't simple could be seen at Merrill Lynch & Co. in New York. There, chief economist Bruce Steinberg predicted the choice would be a half-point. But a colleague, Mary Dennis, an economist in Merrill Lynch's fixed-income group, was looking for only a quarter-point cut.
Fed officials have lowered their target by 4 percentage points this year -- one of the most aggressive efforts in its history to stimulate a sagging U.S. economy. Because rate cuts tend to affect economic activity with a somewhat lengthy and often variable lag, many Fed policymakers believe there is already a lot of economic stimulus in the pipeline.
The combination of Fed rate reductions and the weak state of the economy has caused many market interest rates to fall. Since the beginning of the year, banks' prime lending rate, to which many consumer loans, such as home-equity loans, and small-business loans are tied, has tumbled to 5.5 percent from 9.5 percent. Average rates on conventional 30-year fixed-rate mortgages are down about 2 percentage points, to roughly 6.25 percent. And longer-term rates, such as those of 10-year U.S. Treasury notes, are off about three-fourths of a percentage point, to 4.3 percent.
Yesterday, the Treasury auctioned three- and six-month bills that yielded only about 2 percent.
With the economy so weak despite all the rate declines, some analysts have questioned the efficacy of the Fed's monetary medicine this year. But Fed Chairman Alan Greenspan testified recently that the rate cuts may well have kept the U.S. economy afloat this year as economic growth has stalled.
Of course, the rate reductions are hitting savers as well as borrowers, lowering their interest income. For instance, at Burke & Herbert Bank and Trust Co. in Alexandria, an investor who bought a six-month certificate of deposit that matured yesterday paying 4.12 percent could get only 2.41 percent on a new six-month CD. Similarly, a year ago a 12-month CD got a 5.58 percent yield. Yesterday that was down to 2.55 percent, according to the bank's vice chairman, E. Hunt Burke.
With all those rate reductions in hand, Fed officials are wary of the fact that their targeted federal funds rate, the interest rate financial institutions charge one another for overnight loans, is already at its lowest level since the early 1960s.
"Our sense is that when the Fed meets it won't feel the same sense of urgency that has accompanied the last two half-point cuts," said Thomas Gallagher of International Strategy and Investment, a money-management and advising firm.
"We think the Fed is more comfortable in an incremental rate-cutting mode, and starting quarter-point cuts would allow the Fed to fine tune the end of its easing cycle. Also, [officials] may think it would be hard to resist cutting rates at future meetings if the economic data stay weak, and another half-point rate cut now might not allow them to do so," Gallagher said.
Paul McCulley, an economist and bond fund manager at Pimco mutual funds, said it was not an easy call, adding that he is "really on the fence on this one, just like the market."
"But I'm leaning toward a half-point because, first, the economy is violently going into a recessionary hole. Second, prospects for 'proper' fiscal stimulus are being delayed because of truly mindless bipartisan wrangling in Congress that is limiting or eliminating the scope for anything positive before Christmas," he said.
Peter Hooper, chief economist at Deutsche Bank Alex. Brown in New York, was more firmly convinced the Fed will lower its target to 2 percent rather than 2.25 percent.
"We believe that the Fed has little choice but to cut rates by a half-point again at the meeting, and we've lowered our sights for the bottom of the easing cycle to a 1.5 percent target for the fed funds rate, with that likely occurring no later than February," Hooper said.
© 2001 The Washington Post Company
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BTW, I would be VERY SURPRISED if Greenspan would resign before next year...Yet, if we had a strong replacement (like Bob Rubin), then I believe you might see the mother of all rallys <G>...The market is based on future expectations and I think those that control the Big Money have A LOT of confidence in him.
Regards,
Scott |
