NEW YORK (CNNfn) - In a widely expected move, the Federal Reserve raised short-term interest rates by a quarter point Wednesday in an effort to slow the seemingly unstoppable U.S. economy and ensure prices for goods and services don't begin to creep higher.|
It also shot an onerous warning over Wall Street's bow that it'll raise rates again if the economic party now in record territory doesn't die down a bit.
It was tough love for an economy just celebrating its 107th and record month of uninterrupted expansion. Annual growth is above 4 percent. Unemployment is at a generation low. Prices for goods and services are stable if not falling, and record stock market gains and rising real estate values in 1999 have given Americans more paper wealth than ever.
"The problem is not what's going on now; things are wonderful -- it's what could potentially happen in the future that the Fed and Greenspan are protecting us from," said Stephen Slifer, chief economist with Lehman Brothers. "The economy is chugging along at a pace that's really exceeding the speed limit and that could cause some damage in the long run."
An expected move
For consumers, the Fed rate increase means it's going to cost them more in interest payments on their credit cards and lines of credit at the bank -- increases that the Fed hopes will make them think twice about charging up that dinner or buying that new car. The same goes for companies, who will be dishing out a little more to borrow money to finance their ventures.
Indeed, the nation's banks wasted little time getting down to business Wednesday, raising the prime rate they charge their best customers by a quarter point. Bank of America (BAC: Research, Estimates) took the lead, lifting its prime lending rate to 8.75 percent from 8.50 percent.
For financial markets, the rate increase and the short announcement that followed wasn't all that big a deal. Stocks turned in a mixed performance for the day, while bonds held on to gains already made before the announcement crossed computer screens mid-afternoon.
Surging economic growth, resilient consumer spending, strong manufacturing output, a vigorous housing market, and almost non-existent disruption from the Y2K date change rollover already had convinced most market participants that the Fed would act to slow the economy's progress.
Way harsh, Greenspan
Still, while the move was expected, the strong wording of the statement was not. The Fed said it remained "concerned" that demand for American goods and services could continue to exceed the supply available, "even after taking account of the pronounced rise in productivity growth."
In its revamped statement accompanying the rate decision, the Fed also said that the balance of risks toward inflation gaining speed down the road were "heightened," suggesting more rate increases may be in store.
"Against the background of its long-run goals of price stability and sustainable economic growth and the information currently available, the Committee believes the risks are weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future," the Fed's one-page statement said.
Of course, one of the main missing ingredients in the Fed's battle against inflation of late has been -- inflation.
With the exception of commodities such as oil and natural gas, prices for computers, wireless phones, DVD players and other goods have actually declined. Higher productivity and fierce competition have kept retailers from raising prices while still improving profit margins.
Those voracious consumers
Even so, there's growing concern among investors and Fed officials that the momentum of the U.S. economy, at some point, will spur faster inflation. Much of the economy's momentum is the byproduct of voracious U.S. consumers who, despite three previous rate increases from the Fed, haven't learned to keep their wallets and checkbooks in their pockets.
On Monday the Commerce Department reported that Americans' spending rose almost twice as fast as incomes in December, while personal savings fell to an all-time low.
That followed on the heels of another economic report showing the economy grew at a torrid 5.8 percent pace in the fourth quarter, the strongest showing of the year and well above what economists -- and the Fed -- consider a comfortable rate of advancement for the economy.
Diane Swonk, deputy chief economist with Bank One, told CNNfn that today's rate increase was really only "a drop in the bucket," and that the Fed will likely have to raise rates in quarter-point increments another three times to have a significant impact on consumers' borrowing and spending habits. (524KB WAV) (524KB AIFF)
Too much debt
Whether the economy needs to be tinkered with to slow it down, or whether gains in technology and productivity can allow growth to continue without fueling an increase in prices is the great debate, on Wall Street, Main Street and at the Fed. That aside, one threat to the U.S. economic expansion does seem clear: growing debt levels.
Private-sector debt, according to the Commerce Department, is at the highest levels since the mid-80s. While it's not the same as 1987, when the stock market crash led to a savings and loans debt crisis, it could potentially wreak havoc on the economy if people and business are suddenly forced to repay loans with money they no longer have, said Richard Babson, president of Babson-United Investment Advisors in Boston.
Speaking Monday at the World Economic Forum in Davos, Switzerland, Securities and Exchange Commission Chairman Arthur Levitt expressed his views about rising debt levels among Americans. (324KB WAV) (324KB AIFF) U.S. Treasury Secretary Lawrence Summers expressed his own feelings on the subject Saturday, suggesting a heightened level of national savings was needed to further prolong the current expansion.
That's why the Fed is taking steps now to slow things down, likely raising the Fed funds rate in steady, quarter point increments to avoid causing a significant reaction either within the economy or within financial markets.
Just one of many?
Financial markets agree that that's what's going to happen, judging by the yield on Fed funds futures contracts, which indicate where the market expects rates will be down the road. The yield on the March contract currently rests at 5.91 percent, indicating that most investors expect the fed funds rate to rise another quarter point by the end of March. The next Fed meeting is on March 21.
The big question now is: How many more rate hikes will it take to make the Fed and financial markets comfortable that the pace of the economy will slow enough to avoid an increase in consumer prices?
"Greenspan is trying to be cautious by tapping the brakes ever so lightly, which I think will mean another quarter-point increase soon," Lehman's Slifer said. "This thing has so much momentum that, even though we've raised the speed limit, we're still going a little too fast."
Steven Wood, an economist with Banc of America Securities in San Francisco, agreed.
"Given the momentum in the economy at the end of last year and in the early part of this year, the FOMC will undoubtedly have to raise interest rates yet again," Wood said. "Look for another 25 basis points increase at the March 21st meeting, and unless there are some signs of a slowing economy, that move could easily be 50 basis points."