Fed Expected to Order Half-Point Rate Boost
Federal Reserve policy-makers meeting this week are expected to increase key interest rates by half a percentage point, raising the ante in their increasingly desperate fight against inflation in the booming U.S. economy.
Financial markets have firmly priced in a move in the federal funds overnight bank lending rate--which sets the bar for borrowing costs across the economy--to 6.5% from 6.0%, arguing that the Fed’s five previous quarter-point moves have had little effect on the booming U.S. economy.
“So far, the Fed’s slow-motion monetary policy has been just too predictable, and the market has become immune to it,” said Sung Won Sohn, chief economist at Wells Fargo Bank in Minneapolis. “The purpose will be not to double the pain but to introduce an element of surprise that’s been lost.”
Some of the nation’s top business leaders are bracing themselves for slower U.S. economic growth in the face of mounting wage and borrowing costs.
Chief executives from major U.S. corporations attending the Business Council meeting in White Sulphur Springs, W.Va., last weekend say they are investing in labor-saving technology to boost production and offset higher costs as they wrestle with a paucity of workers and a diminishing power to pass on higher prices to their customers.
While times remain extremely good for most U.S. companies, CEOs are wary that growth could slow this year from unsustainably high levels of 7.3% and 5.4% seen in the last two quarters.
“Business is good--there’s no question about it,” Ralph Larsen, chairman and chief executive of drug maker Johnson & Johnson, told reporters at the twice-yearly Business Council meeting of about 300 top corporations. “But we all have parts of our business that are not hitting on all eight cylinders.”
A Reuters survey of 29 top investment houses Friday showed that 27 of them expect the central bank to raise rates by half a percentage point at the pivotal policy meeting Tuesday. What’s more, a growing number of them now see the federal funds rate rising to more than 7.0% by year-end.
With growth rates lodged in firmly above 5% and evidence of rising wage pressures prompted by the tightest labor market in a generation, the $9-trillion U.S. economy is running at the max as it revels in its longest expansion ever.
“What we’re getting is a string of things coming together telling us a very consistent story,” said Paddy Jilek, director of U.S. economics at Credit Suisse First Boston in New York.
Fed Chairman Alan Greenspan, while a strong believer in the wonders that higher productivity growth has bestowed on the U.S. economy, has long worried that demand is far outstripping supply. Balance can only be restored, he has argued, if the price of money--interest rates--goes up substantially.
Market experts, meanwhile, aren’t just predicting the Federal Reserve will go hard on inflation with a decisive, half-point interest rate hike when it meets Tuesday. Many are hoping for the big one.
This is the thinking: If the central bank sticks with its usual policy of gradually turning up the heat on inflation with modest, quarter-point boosts in borrowing costs, there’s little telling when the monetary tightening could stop.
“If we get a half-percentage-point increase, we will get a bit of a relief rally [on Wall Street],” said Larry Rice, chief investment officer at Josephthal Lyon & Ross in Boca Raton, Fla. “The Fed will be seen as being ahead of the curve. But if we get a quarter of a percentage point, there will be major disappointment.”
The central bank has raised interest rates five times since June to head off inflation, with each increase one of only 25 basis points. A basis point is one-hundredth of a percentage point.
Analysts caution, however, that a hefty rate increase does not give stocks a reason to party like it’s summer break. As a general rule, higher borrowing costs can make it more expensive for companies to finance their operations, a trend that can take a bite out of earnings.
The perception that future profits will suffer is enough to immediately drive down stock prices.
These days, there’s a lot more weighing on the market than just interest rates, said Rick Meckler, senior managing director at Liberty View in Jersey City, N.J. Giving many on Wall Street a migraine is just how to value technology companies that led the record gains in equities before the recent retrenchment.
The Nasdaq composite index rallied Thursday and Friday but still ended off nearly 8% for the week at 3,529. The blue chip Dow Jones industrial average fared better, finishing the week up 0.3% at 10,609.
