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Rate hike is on the way
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June 25, 1999: 2:49 p.m. ET
The Fed is expected to lift rates next week. But what about next month?
By Staff Writer M. Corey Goldman
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NEW YORK (CNNfn) - Investors are all but certain the Federal Reserve will lift short-term interest rates at its policy meeting next week to keep inflation from accelerating and allow the U.S. economy to celebrate its ninth year of uninterrupted expansion.
The question du jour now, it seems, is whether the 12 members of the Federal Open Market Committee -- the arm of the Fed that decides where interest rates should be -- will act just once or whether more rate increases will be on their agenda down the road.
"The market is concerned about not if, but how much over the course of the year the Fed will move," said Michael Gregory, a senior economist at Lehman Brothers in New York. "There's been a lot of discussion about more than one rate increase, which is what's concerning the markets."
Comparisons of past Fed maneuverings have been all the rage of late on Wall Street -- a game market participants love to play.
This is a repeat of 1994, some economists argue, when the Fed steered the economy through what some describe as a "soft landing," raising interest rates in a series of moves to slow growth and keep consumer prices from rising substantially. No, it's 1997, others say, when the Fed opted to lift short-term rates just once -- just to show financial markets it had a grip on things.
Well, as far as Fed Chairman Alan Greenspan is concerned, it's June 1999, and he and his colleagues are most interested in maintaining the now-longest peacetime economic expansion in U.S. history by ensuring inflationary pressures stay away, Gregory said.
No more crises to count on
"As far as the Fed goes, it really isn't inflation on the ground that's a concern, it's inflation down the road," Gregory said. "For a very long time, they've offset that with global concerns, but there doesn't appear to be any more world crises to worry about."
The Fed late last year slashed short-term rates, the "fed funds" rate in financial market-speak, three times in a row in a bid to protect the U.S. from economic turmoil overseas and keep the economy going at a steady pace. It ultimately lowered the fed funds rate -- the trend-setting rate banks charge each other for overnight loans -- to 4.75 percent from 5.5 percent.
Since then, the performance of the U.S. economy has surpassed even the most optimistic expectations. A record number of Americans have jobs. Record amounts of merchandise are flying off store shelves. Dust and wood chips are flying at construction sites. Car sales are speeding along. The stock market is up, travel abroad is up, even wages are up a little bit. The only thing that's been missing is inflation.
One of the principal reasons the Fed allowed the party to last so long was because of what was going on beyond U.S. borders.
More than 40 percent of the world was officially in recession in 1998, according to the Paris-based Organization for Economic Cooperation and Development. Japan was mired in recession. Brazil was facing a debt crisis. Germany was trying to steer itself away from recession, as were Britain and other European countries.
All that and more acted to slow U.S. economic growth by reducing demand for American goods, services and capital abroad, said Sherry Cooper, chief economist at Toronto-based brokerage Nesbitt Burns Inc. Add to that slumping commodity prices and increased productivity among U.S. workers, and you've got yourself a fast-growing, inflation-less economy.
One rate hike? Two? Three? Four?
But those external drags on the economy exist no longer, other analysts contend. Economies in the Far East are showing signs of recovery. Europe is doing better. South America is doing better. Everyone, it seems, is doing better.
"We remain of the view that next week's rate hike will not be the Fed's last work this cycle," Cooper said. "Indeed, they will likely eventually unwind all of last fall's crisis-induced easing."
"Now that the world economy is on firmer footing, investors have grown skeptical that rapid growth can coexist with tame inflation," said Adam Blankman, a market analyst at Standard & Poor's MMS in San Francisco.
To be sure, some economic indicators suggest growth isn't as strong as it seems. Job growth slowed dramatically in May, but workers' wages climbed at a surprisingly brisk pace. Factory orders rose, but so did productivity among workers. New home construction gained, but producers' costs remain tamer than ever.
And inflation remains the uninvited guest who has yet to show up at the party. Prices were flat in June after rising 0.7 percent in May, an increase now widely viewed as a one-month aberration.
The Dow Jones industrial average has gained about 24 percent in the past year
Others, though point to different numbers. The jobless rate still rests at 4.2 percent, a generational low and about 1.7 percentage points below where economists generally deem the "natural" unemployment rate should be for an economy running at its full potential. Growth rang in at 4.3 percent in the first quarter of the year, above the 3-percent range Greenspan himself said would be appropriate for the economy to handle.
And there's that crazy stock market. The Dow Jones industrial average now stands near 10,590, about 24 percent higher than the 8,500-level it sat at before the global financial crisis struck last August.
That market has made helped a lot of Americans boost their incomes and refinance their mortgages, freeing up more money for them to sink into the already robust economy.
Vigilant, not vigilante
That's why, even with clear-as-day assurances from Greenspan that the Fed that "vigilant" does not mean vigilante, participants are looking at a second, third, possibly even fourth rate increase in the months ahead and through 2000, Blankman said.
Financial markets are pricing in at least a half-point uptick in short-term rates. The fed funds futures contract that expires at the end of June currently rests at 4.97 percent -- almost a quarter-point above the current fed funds rate, suggesting the market has already priced in that much of a rate increase.
The fed funds future contract that expires in September, however, now rests at 5.20 percent, suggesting market participants are bracing for a second quarter-point rate hike by summer's end.
Lehman's Gregory believes the Fed will raise rates only once in 1999 and then wait to see the effects of that on the economy before moving again.
"Our view is that it's going to be a one-time shot," he said. "Growth will continue to slow down and productivity, to an extent, will help keep prices from rising. That may get the Fed thinking they don't have to do this again."
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