How Do Interest Rates Look Next Year?
By Catherine Valenti ABCNEWS.com
Thursday December 13 11:52 AM EST
Will Tuesday's interest rate cut — the eleventh of the year — be the last?
As expected, the Federal Reserve (news - web sites) cut its key interest rate by a quarter-point to 1.75 percent. But what's less certain now is whether there are any more cuts in the nearly yearlong campaign to jump-start the economy.
The move marked the 11th time that the central bank lowered its key federal funds rate. At 1.75 percent, the rate is the lowest since July of 1961.
While some market watchers had expected the cut to conclude the Fed's attempts to give the ailing economy a jump-start, others say more rate cuts could be on the horizon for early next year.
And indeed, the Fed's statement said that the central bank is still attentive to weakness in the U.S. economy.
"To be sure, weakness in demand shows signs of abating, but those signs are preliminary and tentative," read the Fed's statement. "The Committee continues to believe that, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."
Statement Key
Clues to the Fed's next move normally lie in the statement it releases with its rate decision, as well as what happens with the economy itself. Economists say if the Fed continues to see further economic risks on the horizon, more rate cuts could be in store for next year.
"We are in an economic slowdown that we had not yet seen for at least 10 or 20 years and the Fed sees many reasons out there to stimulate the economy," says Jonathan Murray, financial adviser with Legg Mason Wood Walker in Baltimore. "And by lowering short-term interest rates, it makes the economy grow more quickly."
But most experts agree that if the economy does turn around during the first half of next year, the Fed will probably start raising rates later next year.
"If the economy does mend as expected, then you'll be looking at the return of Federal Reserve rate hikes in the second quarter of next year," predicts Moody's chief economist John Lonski. "The Federal Reserve is simply not going to be putting as much downward pressure on borrowing costs as it has all of this year."
Risks Still Lurking
The signs of weakness and recovery are indeed a challenge for economy watchers to sort out. The National Bureau of Economic Research, the arbiters of boom and bust cycles, has declared that the country has been in a recession since March, citing a significant decline in industrial production, employment, real income and wholesale retail trade.
But some economists note that relatively strong consumer spending, especially in automobiles, and a still solid housing market could help to keep the economy afloat. Consumer spending makes up two-thirds of the country's gross domestic product. Still, others note that risks to the economy remain.
Lehman Brothers' co-chief economist Ethan Harris points to November's unemployment figure, which jumped to 5.7 percent — the highest rate since August of 1995. Lehman Brothers expects the jobless rate to rise to 6.4 percent in 2002.
"Frankly, we're quite skeptical that the turnaround is here," says Harris. "The employment report on Friday is a great example of that."
Harris, who says he expects the recession to continue until March, predicts that the Fed will actually lower rates one more time in 2002, either during its Jan. 30 or March 19 meetings. That's because historically, the Fed has continued to lower interest rates an average of two months after the recession is over.
Giving the Fed less of a reason to raise rates is inflation, which has been mild and is expected to get even milder. Rising inflation is often one of the main reasons why the Federal Reserve decides to hike interest rates. Lehman's Harris sees the core consumer price index in 2002 dropping to 1.6 percent from an estimated 2.6 percent this year.
That said, Harris does expect the Fed to start raising rates in the second half of the year, and sees the federal funds rate peaking at three percent by the end of 2002.
Still Time to Refinance
Another important factor behind what the Fed will do next year is whether or not Congress passes its much-anticipated stimulus package. If it does, the central bank may not see the need to cut rates further next year, preferring instead to let the effects of a stimulus package filter through the economy. If a stimulus package is not passed, that could mean more bad news for a recovery, says Moody's Lonski.
Mark Zandi, chief economist of economic research web site Economy.com, agrees. ""Whether or not we get an economic stimulus package in the next few weeks will be a large determinant of policy," he says.
So what will today's move mean for consumers? Probably not much, say experts. Thirty-year fixed rate mortgages are already moving higher, and experts say the bottom in mortgage rates is probably in the rear view mirror. But this week's rate of 6.84 percent for a 30-year mortgage (according to lender Freddie Mac) is still historically pretty low, so consumers who want to refinance can still get a good deal, says Bankrate.com's McBride.
"The window of opportunity is still open," says McBride. "Rates right now are still very attractive relative to averages." |
