Fed set to cut again
Economists see an aggressive cut, but the Fed may need some help.
NEW YORK (CNNmoney) - The Federal Reserve is widely expected to cut interest rates for the 10th time this year when its policy makers meet Tuesday, and recent economic data indicate the central bank will probably continue to be aggressive.|
After two half-percentage point cuts since the Sept. 11 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.
But 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 as the central bank extends its attempt to keep consumers spending and fend off a recession in the United States.
"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 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 also show investors are betting another half point cut is likely Tuesday. But the contracts, which indicate where investors think the short-term rate is headed, 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 some 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."
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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.
Monday's reports of hundreds of thousands of job-cut announcements in October and a shrinking service sector did nothing to change the picture of an economy in dire need of a boost.
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 in ways the Fed's rate cuts haven't.
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Where Fed cuts are now most effective, analysts say, is in shoring up sagging confidence by letting consumers - and the sensitive U.S. stock market - know the central bank is 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 near 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.
"The confidence of consumers is going to be related more to the issue of terrorism and war than to anything fundamental," Joel Naroff said. "If things turn, that'll turn confidence, and that'll stop the downslide very quickly."