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Fed may not be done
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December 11, 2001: 10:26 a.m. ET
The Fed is likely to set a record, but rate-cutting campaign could continue.
By Staff Writer Mark Gongloff
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NEW YORK (CNN/Money) - Federal Reserve policy makers will almost certainly cut interest rates one more time Tuesday, at the end of their last scheduled meeting of 2001, setting a record for the most cuts in a single year.
Of 21 economists surveyed by CNN/Money and CNNfn on Monday, 19 thought the Fed would cut a quarter percentage point, one thought the Fed would cut a half point and one thought there was a 50/50 chance there'd be no cut at all. A decision on rates is expected at 2:15 p.m. ET.
But will 11 cuts, likely taking the targeted federal funds rate to a 40-year low of 1.75 percent from 6.5 percent at the start of the year, do the trick and save the U.S. economy? Maybe not, especially after Friday's grim unemployment report.
"They're not done. They're giving us another present in January," Robert Froehlich, chief investment strategist at Zurich Scudder Investments, told CNNfn's Before Hours program. "You can't lay off [people at] company after company after company and not stimulate this economy. I think the Fed is scared to death."
Though all 24 economists surveyed by Reuters last week expected a quarter-point cut, Froehlich expects the Fed to cut rates a more dramatic half point, in part to help erase its own mistake in raising rates in 1999 and 2000. (485K WAV) or (485K AIF)
It's too early to tell how consumers took the news of 5.7 percent unemployment and the worst two months of job losses in 20 years. Friday's reported gain in the University of Michigan's consumer sentiment index was the result of a survey taken before the unemployment data was released.
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Can further rate cuts continue to stimulate the economy? CNNfn's Kathleen Hays takes a look.
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And Wall Street was jittery ahead of the Fed decision; stocks posted tentative gains in early trading Tuesday, but fell Monday, with the Dow and Nasdaq both losing more than 1.0 percent.
The Fed is probably not going to wait around for sentiment numbers to sink before it cuts again; it will likely keep pushing rates down until it sees real evidence that consumers, who fuel two-thirds of the economy, are borrowing and spending money.
"They will cut until they reach the point that the average consumer finally cries 'uncle' and starts to take on risk," said Bill Gross, manager of the Pimco Total Return bond fund, the largest in the world with $50 billion under management.
Before Sept. 11, that moment seemed near at hand, and the Fed's aggressive rate-cutting battle was almost over.
"The easing process probably [will] have to be terminated before available measures of economic activity [provide] clear evidence of a substantial strengthening trend," the Fed said in the minutes of its August 21 meeting, at which policy makers agreed to cut rates by a quarter percentage point.
"In the view of some members, this point might come relatively soon," the minutes added.
But the attacks of Sept. 11 not only worsened a slowdown in business activity -- which caused a year-long recession in the manufacturing industry and a general recession that probably began in March, some economists say -- they had the effect of rattling the last rock-solid pillar of American economic strength, consumer confidence.
In response, the Fed returned to an aggressive rate-cutting campaign, making half-point cuts on Sept. 17, Oct. 2 and Nov. 6. With each cut, the Fed also kept its easing "bias," saying the forces at work in the economy were mostly bad and that it was prepared to cut rates again, if necessary.
Meanwhile, U.S. gross domestic product (GDP), the broadest measure of the economy, shrank at a 1.1 percent rate in the third quarter, meaning we're halfway to a recession, as commonly defined. Separately, the business-cycle dating gurus at the National Bureau of Economic Research said recently that a recession actually began in March.
And a few Fed officials have remarked in recent weeks that the economy might not get better right away, which Wall Street has interpreted to mean they're gung-ho about rate cuts. Fed sources, though, have suggested that the press and analysts may be overreacting.
The latest policy maker in the spotlight was New York Fed president William McDonough, who told a conference Thursday that it was impossible to say for certain when the economy was going to turn around. That was interpreted by some as being another sign of the Fed dousing hopes for a quick rebound.
"He wasn't trying to comment on the economy," a source at the New York Fed said. "He said the economy would turn around -- it always turns around -- but nobody knows the exact timing."
Some Wall Street observers had hoped that recent better-than-expected economic data, including falling weekly claims for unemployment benefits, signs of life for manufacturing and an apparent rebound in the service sector, were signs that the economy's recovery would make a "V-shaped" bounce early next year.
But the recovery could be held back by the worsening job market. Though unemployment is a lagging indicator, meaning it will continue to rise even when the economy is recovering, it could undercut consumer sentiment and spending.
Click here for more on the Fed and rates
After Friday's unemployment data, many economists began to reassess their outlook for next year's recovery, and the overwhelming majority of them now think another rate cut Tuesday is inevitable.
Of course, there's also some danger that yet another rate cut could be interpreted as a sign of desperation -- after all, shouldn't ten rate cuts be enough? Is the United States going to end up looking like Japan, the world's second-largest economy, where interest rates are zero, but the economy is in the throes of another recession?
"A quarter-point cut could weaken confidence by reinforcing pessimism in the market place," said Sung Won Sohn, chief economist at Wells Fargo & Co. "Instead, [Fed] Chairman Greenspan should stand pat, sending a positive message that economic recovery is in sight and no additional monetary stimulus is needed."
Inflation, a distant memory, could also rear its ugly head again if all these rate cuts, combined with low energy prices, a possible multi-billion-dollar economic stimulus package from Congress and other factors, flood the economy with money.
Fears about inflation and deficit spending by the government have worked against the Fed somewhat, as bond investors have driven up long-term interest rates to keep up with what they think inflation will be.
Still, with an economy in recession, the usual remedy is to put short-term rates at or below the rate of inflation, to make spending more attractive than saving.
"The Fed knows that the economy is in terrible shape and that they must bring down short-term rates to the level of inflation," said Pimco's Gross. "If inflation keeps coming down, the Fed, to a certain extent, has to chase inflation."
That's one reason the Fed might not start raising rates again any time soon, as some bond investors fear. On the other hand, Gross pointed out, elderly people who rely on certificates of deposit and money market accounts will suffer if low interest rates persist for too long, adding to the Fed's conundrum.
"It's a very delicate balance," Gross said. 
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