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Rate cut seen, but how big?
June 27, 2001: 8:11 a.m. ET

Wall Street speculates on the size of expected interest rate cut
By Staff Writer Mark Gongloff
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NEW YORK (CNNfn) - The Federal Reserve is widely expected to cut interest rates for the sixth time this year at the end of its policy meeting Wednesday, but economists are divided about the size of the cut.

A slim majority of economists expect the central bank to cut the federal funds rate, its target for an overnight bank lending rate, a quarter percentage point to 3.75 percent. But recent reports have painted an uncertain picture of the economy, and the number of analysts expecting a half-percentage-point cut has been growing almost daily.

"Though the (economic data) have been mixed, they've been more negative than positive, and the outlook for the risks the economy faces is distinctly on the downside," said Michael Moran, chief economist at Daiwa Securities, who thinks the Fed will cut by a half percentage point. "The Fed has more to gain by erring on the side of accommodation."

Others think the Fed's rate-cutting campaign is or should be nearly over, and the central bank will be mostly content to wait for the economic impact of the 2.5 percentage points it's already slashed from short-term interest rates this year.

"I think they don't want to send an aggressive signal, but they want to start preparing the market for the fact that they're nearing the end" of their easing campaign, said Dick Berner, U.S. economist at Morgan Stanley, who thinks the Fed will cut by only a quarter point.

In a Reuters poll conducted June 22, 15 of the 25 primary dealers authorized to work with the central bank in the money markets said they expect the Fed to cut rates a quarter point, but that number was shrinking rapidly.

Even the bond market is uncertain about where interest rates will stand after the Fed's announcement, expected at 2:15 p.m. ET. The implied yield on the July federal funds futures contract which hints at the market's expectations about Fed activity is at 3.65 percent, meaning the bond market thinks the chances of a quarter-point rate cut next week are a little better than 50-50.

Rate-cutting campaign near an end?

It's hard to believe that only a year ago the Fed had just finished raising rates in a bid to slow the economy and avoid inflation, boosting the fed funds rate to a nine-year high of 6.5 percent.

Fed Chairman Alan Greenspan on his way to the Fed policy-makers' meeting Wednesday morning
The higher rates persuaded companies to cut corporate spending on new technology, and at the same time energy costs were soaring. What followed? The Internet bubble burst, the stock market tumbled, with tech stocks especially hard hit, and consumer confidence sank. Soon companies began cutting hundreds of thousands of jobs.

The result has been an economic slowdown that the Fed has been desperately trying to halt since the start of the year, slashing the fed funds rate to 4 percent, its lowest level since May 1994.

Many think its work is almost done, especially since the U.S. government will begin mailing tax-rebate checks to millions of taxpayers soon.

"Hopefully, by August (when the Fed next meets), we should have a pretty good idea that the economy is expanding," said Sung Won Sohn, chief economist with Wells Fargo & Co., who thinks the Fed will cut rates by a half point this week. "A tax rebate and earlier cuts will be working. If the Fed cuts in August, we will worry more about them overdoing it."

Economic uncertainty

Still, the Fed does not appear overly concerned about inflation. Fed Chairman Alan Greenspan, speaking before a Senate Banking Committee hearing last week, said he saw little inflation pressure on the economy.

Most economists agree that the possibility of a slowdown lingering or picking up pace is a bigger concern for the Fed right now than inflation.

"I look at this as the closing of a window of opportunity to raise rates," said Robert Brusca, chief economist at Ecobest Consulting, who thinks the Fed will cut by a half-percentage point this week. "If they're more aggressive, they're more likely to have an immediate effect on people's psychology. If they're too aggressive, they can undo that. If they're not aggressive enough, they can't undo that."

Beyond the apparently low inflation risk, there is little certainty, as recent economic reports have presented a mix of good news and bad news.

The good news Tuesday was that consumer confidence surged in June, while new home sales and orders for high-priced durable goods like cars and computers posted surprising gains in May. The bad news was that confidence and durable-goods orders were still lower than a year ago, and economists didn't think the data would much affect the Fed's decision Wednesday.

"Even though there are signs that the economy is starting to pick up steam again and that things probably have bottomed out, they'd be pretty safe with a [half-percentage-point] cut this time around," Marci Rossell, corporate economist at Oppenheimer Funds, told CNNfn's Market Call program Tuesday.

Data released last Thursday showed that new claims for unemployment came in lower than expected. But they also stayed above 400,000 for the fifth straight week, the longest streak since the end of the last recession, pointing to continuing job-market weakness.

When people fear for their jobs they usually spend less, and the Fed keeps a close eye on consumer spending, which fuels two-thirds of the U.S. economy.

Click here for CNNfn's economic calendar

Last week, the National Bureau of Economic Research (NBER), which is usually one of the first organizations to recognize a recession, said it's possible a recession in the U.S. economy began recently, based on recent declines in employment and industrial production.

Still, the NBER isn't yet pushing any panic buttons and said its business cycle dating committee, which decides when recessions begin and end, hasn't yet seen enough data to merit a meeting.

Stock market performance can also affect consumer confidence, but U.S. markets haven't responded particularly well to Fed cuts this year. Since the Fed's last cut May 15, the Dow Jones industrial average is much lower, while the Nasdaq is little changed.

"I don't think the market is going to blast off [Wednesday] if the Fed cuts 50 basis points," said Bill Ryder, chief quantitative strategist at First Union Securities. "Any kind of excess reaction [to a rate cut] is corrected over a couple of weeks."

Another factor the Fed might consider is the length of time until its next scheduled policy meeting Aug. 21, an eight-week stretch.

"There's quite a long time before the next meeting," said Richard Rippe, chief economist with Prudential Securities, who thinks the Fed will cut by half a point. "If they cut (a quarter-percentage point), they could make statements, as they've done in the past, that they will 'monitor developments closely,' which is a hint that they could cut again before the next meeting," Rippe said. graphic

-- Staff Writer Kim Khan contributed to this report


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