Fed Holds Bank Rate at 1.75%, Sees Weakness as Risk. 30-Year T-Bond now a tad under 5% heading south.
quote.bloomberg.com
08/13 14:30
Fed Holds Bank Rate at 1.75%, Sees Weakness as Risk (Update1)
By John Cranford
Washington, Aug. 13 (Bloomberg) -- Federal Reserve policy makers took a step toward lowering U.S. interest rates for a 12th time in two years by saying the risks of an economic slowdown outweigh the threat of inflation.
Central bankers left the benchmark overnight bank lending rate at a 41-year low of 1.75 percent and indicated the economy's recovery from recession is less assured than it was just a few months ago.
``The softening in the growth of aggregate demand that emerged this spring has been prolonged in large measure by weakness in financial markets and heightened uncertainty related to problems in corporate reporting and governance,'' the Fed said in a statement accompanying its decision.
The benchmark 10-year Treasury note rose and stocks fell after the announcement. Economic growth slowed in the second quarter to a 1.1 percent annual rate, down from a 5 percent pace in the first three months of the year, and the third quarter may not be better. Manufacturing and services stalled in July, and the economy added 6,000 jobs, less than a 10th of the number created a month earlier.
While most economists say the recession that began in March 2001 ended at the start of this year, a growing number say a 21 percent decline in the Standard & Poor's index of 500 stocks this year may constrain consumer and business spending. That may lead to slower growth than was expected as recently as last month. The Blue Chip Economic Indicators consensus forecast is now for 2.3 percent growth this year, down from 2.8 percent in July.
Business Investment
Fed officials have said that the recovery won't fully be in place until companies start investing. Business spending on equipment and software rose in the second quarter for the first time in almost two years. Still, fixed investment, which includes spending on office space and factories as well as equipment, will probably decline 5.1 percent this year, more than estimated two months ago, the Blue Chip survey showed.
``We're still facing a very, very challenging economic environment,'' said Scott McNealy, chairman and chief executive at Sun Microsystems Inc., in an interview with Bloomberg Television yesterday. ``I don't know anybody who's running around saying they see a great upturn.''
The 4 3/8 percent note that matures in August 2012 rose 5/8 point, pushing down its yield 8 basis points to an all-time low of 4.14 percent. The Dow Jones Industrial Average fell 70 points, or 0.8 percent, as of 2:20 p.m. Washington time. The Nasdaq Composite Index dropped 7 points, or 0.5 percent.
Expecting a Change
Nine of the 22 banks and securities firms that trade with the Fed had predicted that central bankers would drop the view they've held since March that the risks to the economy are balanced, and reflect increasing concern that the recovery is in jeopardy.
The change in the Fed's statement sends ``a strong signal that it is well aware that the real economy is being dented by financial market volatility,'' said Lawrence Goodman, managing director at Globalecon LLC, a New York advisory firm, before the announcement.
Goodman didn't expect the Fed to lower the overnight rate today, sharing the view of most economists in a Bloomberg News survey. Two of the 101 economists polled -- Richard Berner, chief U.S. economist at Morgan Stanley, and Robert McGee, senior strategist at UFJ Bank -- predicted a half-percentage-point cut.
Rate Cut Predictions
They aren't alone in forecasting lower rates at some point. Deutsche Bank Securities, Dresdner Kleinwort Wasserstein Securities LLC, Lehman Brothers Holdings Inc. and Goldman, Sachs & Co. have said they anticipate the Fed will reduce the overnight rate before yearend. And the 1.59 percent implied yield on the October federal funds futures contract indicates that investors are betting a rate cut may come by September.
The Fed's announcement may extend the most aggressive series of rate reductions in Alan Greenspan's 15-year tenure as Fed chairman. Beginning with an emergency rate cut Jan. 3, 2001, central bankers lowered the target rate for overnight loans between banks 11 times last year by a total of 4 3/4 percentage points to combat the economy's weakness. The last rate cut came Dec. 11.
The S&P 500 is headed for a third consecutive annual decline as weak earnings, corporate malfeasance and concerns about the fragility of the economy's recovery weigh on American optimism. Consumer confidence, as measured by both the New York-based Conference Board and the University of Michigan, slumped last month.
Consumer Spending
Most economists, though, expect no change in interest rates. Half of those surveyed from July 26 through Aug. 7 by the National Association for Business Economics said the Fed would hold the overnight rate steady for the next six months, while 31 percent said central bankers would raise rates. Just 18 percent of the 193 economists surveyed expected a reduction in borrowing costs.
At the same time, there are signs consumer spending, which sustained the economy during the recession, hasn't flagged. Retail sales rose 1.2 percent in July, the third increase in four months, the Commerce Department reported today. Autos sold at an 18.1 million annual rate last month, the most since October.
A return to zero-interest financing by General Motors Corp. and other carmakers helped induce the surge of car-buying. Still, when autos aren't counted, retail sales rose 0.2 percent in July.
Home Refinancing
Low interest rates have also spurred applications for mortgage refinancing, figures from the Mortgage Bankers Association of America show. The group's index measuring refinancing at the end of July was close to the highest in more than a decade of record-keeping.
The average rate on a 30-year fixed mortgage fell to 6.31 percent last week, the lowest since Freddie Mac, the No. 2 buyer of U.S. mortgages, began keeping track in 1971.
The rise in refinancing may undergird spending as homeowners use their houses as a source of cash. And low rates explain why housing industry officials expect sales of new and previously owned homes this year to exceed last year's record of 6.21 million.
Fed policy makers gave little indication in public comments this month that they were having doubts about the recovery continuing, or that they might entertain proposals to lower rates.
Robert Parry, president of the San Francisco Fed Bank, dismissed concerns about declining stock prices. ``There are some good reasons why we shouldn't be surprised that equity markets have fallen,'' Parry said in a speech Aug. 2. ``Even with these concerns, it is important to remember that there are several factors that are boosting growth and that are very likely to boost growth in the future.''
The Fed's policy-setting Open Market Committee was at full strength today for the first time in three years. Two new members, Ben Bernanke and Donald Kohn, were sworn in as Fed governors last week, filling seats that have been vacant since the beginning of the year. All seven members of the Board of Governors are voting members of the FOMC as are five of the 12 regional Fed bank presidents. While the presidents take turns voting, all participate in the discussions.
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