NEW YORK (CNN/Money) -
When economists and investors fret about Fed rate hikes, they often point to 1994 as an example of what happens when the central bank takes Wall Street's punch bowl away.
Abrupt rate hikes made 1994 an unpleasant year for Wall Street, but a more recent example could give investors some hope: in 1997, when the Federal Reserve raised rates just once and then quit.
Though such a short-lived campaign seems unlikely this time, some analysts say Fed Hike 2004 could fall in the comfortable middle between 1994 and 1997.
Fed policy-makers meet on June 29-30 to discuss their target for the fed funds rate, an overnight lending rate the central bankers manipulate to heat up or cool off the economy. The rate's currently at 1 percent, the lowest in more than 40 years, and pretty much everybody expects the Fed to raise it by at least a quarter percentage point this month.
The big question is what happens next. Most analysts also expect the Fed to ratchet rates up more than once this year, taking the fed funds rate perhaps as high as 2.25 percent, according to current market expectations.
Though the Fed has promised to be "measured" in raising rates -- and there are signs lately that it will be -- inflation hawks still worry the Fed is woefully behind the curve, and could be forced to jack rates drastically higher in a bid to cool the economy and ward off inflation.
If they're right, 2004 will be painfully reminiscent of 1994, when the Fed started raising rates with modest, quarter-point hikes in February, March and April and ended up making half-point hikes in May and August and a whopping, three-quarter-point hike in November. Then they added another half-point hike in early 1995 for good measure.
That was no fun for Wall Street then, and it wouldn't be a barrel of laughs now, either.
Far less painful was the Fed's campaign in 1997, when the Fed raised rates a quarter point in March and called it quits the rest of the year.
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Unfortunately, though, the Fed's caution then was due to a blossoming financial crisis in Asia, and most analysts believe it would take another such shock -- a terrorist attack, or oil above $50 a barrel, for example -- for the Fed to take a "one and done" approach this year.
"You can bet on it, but only if you like betting on the long shot in the Preakness or the Belmont," said Robert Brusca, chief economist at Fact and Opinion Economics. "You've got to be willing to take 40-to-1 odds -- it may be a horse race, but a bad one."
Will the Fed be like Birdstone?
Of course, as you may know, 36-1 long-shot Birdstone won the Belmont this year, and some of the most bearish economists think a return to 1997 could be in order this year, as well.
For one thing, the looming presidential election could make the Fed loath to step on the economy's brakes too aggressively. Some members of the Bush family still may blame Fed Chairman Alan Greenspan for the first President Bush's loss in 1992, saying Greenspan's Fed was too slow to cut rates amid a slowdown.
Meanwhile, terrorist attacks and oil-supply disruptions aren't exactly in the realm of fantasy these days. And the bears believe highly leveraged consumers are vulnerable to the disappearance of stimuli such as tax cuts and super-low rates.
"Powerful restraining forces are impacting the consumer, and this will result in slower growth in the latter part of this year and into 2005," Van Hoisington and Lacy Hunt, the chief investment officer and chief economist, respectively, of Hoisington Investment Management in Austin, wrote in a recent note to clients.
"As a consequence, we fully expect interest rates to be lower by year end, and noticeably lower a year from now."
No doubt, their view is in the minority. Most economists say that stronger job growth is starting to boost consumer income, and corporate profits have surged, meaning both consumers and corporations can better endure higher rates.
"The economy is less interest-rate sensitive than it was a year ago because of income growth, and we have corporate profits higher than capital spending -- a condition only seen rarely in the past 40 years -- meaning companies don't need to borrow as much," said Anthony Crescenzi, bond market analyst at Miller Tabak.
"That makes it more likely we will need to have repeated hikes, because the economy won't succumb to a small handful of hikes."
One extreme to another
Still, there's little doubt the Fed learned a painful lesson in 1994. By July 1995, less than six months after the last rate hike of the 1994-95 hiking campaign, the economy was suffering so much that the Fed had to start cutting rates again.
Inflation fears, rampant on Wall Street in 1994, as they've been again this year, turned out to be unwarranted, and so it may be again this year.
"The big surprise in 1994 was that, despite all the inflation scares -- and there was tremendous inflation worry -- core inflation actually fell in 1994," said David Rosenberg, chief North American economist at Merrill Lynch.
Rosenberg believes that, after 1994, the Fed got the religion of rising productivity, which tempers labor costs, the biggest component of inflation. Productivity kept inflation tame in the following decade and may do so again this year, enough to allow the Fed to raise the fed funds rate gingerly, to just 1.5 or 1.75 percent by the end of the year, Rosenberg believes.
"A year ago, 'deflation' was dripping off everybody's lips," Rosenberg said. "Today, core inflation is off its low, but it's about the same as it was a year ago, yet all anybody can talk about is how far the Fed will hike."
"We've gone from one extreme to another," he added, "but investment opportunities are born in such extremes."
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