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Fed set to cut again
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November 4, 2001: 7:00 a.m. ET
Economists see an aggressive cut, but the Fed may need some help.
By Staff Writer Mark Gongloff
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NEW YORK (CNNmoney) - The Federal Reserve is widely expected to cut interest rates for the tenth time this year after its policy meeting Tuesday, and recent economic data mean the Fed will probably continue to be aggressive.
After two half-percentage point cuts in short-term rates since the Sept. 11 terror attacks - the eighth and ninth cuts of the year - took rates to 40-year lows, many observers thought the Fed would ease up and cut only a quarter-percentage point this time.
Friday's weaker-than-expected unemployment data, following a weaker-than-expected report on the manufacturing sector Thursday, changed that.
"Recent events have raised chances of still another [half-percentage-point] cut in rates just when all had been expecting a throttling back in the rate of easing," said Salomon Smith Barney economist Robert DiClemente.
Now, most economists expect the Fed to take its target for the federal funds rate, an overnight bank lending rate, to 2.0 percent from 2.5 percent in order to keep consumers spending and fend off a recession in the U.S. economy.
"With labor markets eroding rapidly, external growth faltering badly, and domestic inflation low and falling, the Fed can afford to err on the side of accommodation," DiClemente added.
Fifteen of 24 money managers surveyed by Reuters on Friday agreed, saying they expected a half-percentage point cut, while nine expected a quarter-point cut.
And 23 of the 24 economists surveyed said they expected an 11th rate cut to follow the Fed's policy meeting on Dec. 11, which would be the most cuts within one year in Fed history. Within this group, 20 expect a quarter-point cut at that meeting.
Futures contracts on the fed funds rate - which point to where investors think the short-term rate will go - also show that investors think it's likely the Fed will cut by a half percentage point on Tuesday. But the contracts are not pricing in another Fed cut this year, conflicting with economists' expectations.
The prospect of inflation is one factor that could keep the Fed from making another cut after Tuesday. Though inflation hasn't been a problem for a long time, Congress will soon add its own fuel to the fire by appropriating billions of dollars in tax cuts and spending - leading to a sudden, dramatic influx of money when the economy picks up again.
"Looking ahead beyond the current gloom, there is a serious risk that we already have inflationary forces baked into the system," said Bill Cheney, chief economist at John Hancock Financial Services. "By late spring, the Fed could be cranking up interest rates even faster than they cut them."
"For now, however, inflation is a problem that we would welcome," Cheney added. "Over the short-term, in the absence of any current inflation threats, it makes sense to do whatever we can to get the economy moving again."
Click here for more on the Fed and rates
Most economists expect a recession, commonly defined as two consecutive quarters of shrinking gross domestic product (GDP), to follow the attacks. The government's initial reading of third-quarter GDP was slightly negative, meaning the first shoe has dropped.
The Fed's goal in cutting rates is usually to make borrowing cheaper and spur consumer spending, which makes up two-thirds of GDP. Many analysts have begun to wonder if the Fed is really able to do that after making nine cuts that took rates to 40-year lows.
"They're giving a few more dollars to people who have home equity credit lines, which is really about the only place left where the Fed is helping," said Joel Naroff, chief economist at Naroff Economic Advisors. "We're really not talking about a whole lot of impact."
Highlighting the corner in which the Fed finds itself, the Treasury Department's decision last week to discontinue selling 30-year bonds boosted those bonds' prices and sank their yield, which moves inversely to price, to lows not seen in three years, affecting long-term interest rates - and possibly corporate profits - in ways the Fed's rate cuts haven't.
"Since the ability to refinance or restructure debt is one of the incremental drivers of a profit trough, the importance of this policy change cannot be overemphasized," said Christine Callies, chief U.S. investment strategist at Merrill Lynch.
Where Fed cuts are now most effective, analysts say, is in shoring up sagging confidence by letting consumers know it's doing everything it can to help the economy.
Beyond that, if the U.S. economy is to avoid looking like Japan's, where interest rates are at zero, but people still won't spend money, analysts agree that Congress must pitch in with its own economic stimulus.
"Japan's big problem was that fiscal stimulus was not there," said Robert Macintosh, chief economist at Eaton Vance Management. "They haven't coordinated monetary policy with fiscal policy. That's what we're doing differently, and that's why we won't have the same problem."
Most economists think the combination of actions by the Fed and Congress will set the stage for an economic rebound some time next year, possibly as early as the spring. But that outlook could be altered by a dramatic setback - or triumph - in America's war on terrorism, both at home and abroad.
Click here for CNNmoney.com's economic calendar
Falling stock prices have also put a damper on consumer spending, and the Fed has paid increasing attention to the markets in recent months.
Though U.S. stocks have mostly yawned at Fed actions this year, it will be interesting to see how Wall Street reacts to good news like a rate cut now. It's gotten plenty of bad news in the past few weeks and has responded with one stirring rally after another.
"This market is shrugging off negative news like it never has before," Brian Finnerty, head of Nasdaq trading at C.E. Unterberg Towbin, told CNNfn's Market Call program.
Since bottoming Sept. 21, the Dow Jones industrial average has gained as much as 16 percent, while the Nasdaq composite index has seen a 27-percent advance. In the latest week, however, the Dow fell 221.63 to close at 9,323.54, while the Nasdaq lost 23.23 to close at 1,745.73.
Wall Street could get more bad news about corporate earnings this week. Fiscal first-quarter profits at Cisco Systems Inc. (CSCO: Research, Estimates), the maker of Internet equipment, are expected to fall 88 percent when the company reports Monday.
Analysts surveyed by First Call expect that Cisco earned 2 cents a share, down from 18 cents in the year-ago quarter. From its all-time high above $80 last year, Cisco stock has fallen 78 percent.
Qualcomm Inc. (QCOM: Research, Estimates) results will likely be better. The maker of wireless communications is expected to post flat earnings of 25 cents a share in the latest quarter.
But Walt Disney Co. (DIS: Research, Estimates) won't be immune from the slide in advertising affecting other media companies. Disney is forecast to post profits of 7 cents a share, according to the consensus estimate. That's down more than 50 percent from year-ago figures.
Earnings at Disney rival News Corp. (NWS: Research, Estimates) are seen dropping to 11 cents from 14 last year.
When all is said and done, profit in the September quarter is expected to decline more than 20 percent, followed by more weakness in the quarter and next quarter.
And still more bad news could come Friday, when the University of Michigan releases its preliminary look at consumer sentiment in November. Economists surveyed by Briefing.com expect another drop.
October's producer price index, due the same day, is expected to show that wholesale prices slipped, another sign of little inflation. 
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Special Report: Eyes on the Fed
Another rate cut by the Fed will add to historic campaign - Nov. 2, 2001
U.S. job cuts, unemployment up in month - Nov. 2, 2001
U.S. manufacturing activity shrinks for 15th straight month - Nov. 1, 2001
Personal spending, jobless claims fall - Nov. 1, 2001
U.S. GDP shrinks in 3Q - Oct. 31, 2001
U.S. government ends issuance of 30-year bond - Oct. 31, 2001
Some worry Fed rate cuts no longer effective - Oct. 3, 2001
Federal Reserve cuts interest rates for 9th time in 2001 - Oct. 2, 2001
Recession could follow terror attacks, but it might not last long - Sept. 20, 2001
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