Rate Cut Unlikely Amid Muddle
With the economic picture as muddled as ever, don’t expect another interest rate cut from the Federal Reserve at Tuesday’s meeting.
That’s the view of most economists and money managers, who say the stock market shrugged off Friday’s weak employment report and rallied because the data failed to address the key question on everybody’s mind, including Fed Chairman Alan Greenspan’s: Where is the U.S. economy headed now that the Iraq war is over?
“It’s too early to say whether the economy is or isn’t jumping back,” said David MacEwen, chief investment officer of fixed income at American Century Investments in Mountain View, Calif.
Despite the anemic job market, there are signs that the economy might be perking up, MacEwen and others note.
For one thing, corporate profits are improving. First-quarter earnings for the companies in the benchmark Standard & Poor’s 500 index are expected to be up an average of 13% compared with last year, once all the companies have reported.
Before companies spend money on labor, plants and equipment, they need to see improving profitability, analysts say. The pickup in earnings among S&P; 500 companies may be one reason stock investors didn’t get into a funk over Friday’s tepid employment report for April. The Labor Department said the economy lost a net 48,000 jobs and the unemployment rate spurted up to 6%, matching December’s peak, from 5.8% in March.
Still, the job losses were less than many analysts were expecting, and a manufacturing report released the same day showed surprisingly strong growth.
The uncertain prognosis for the economy was evident in the bond market last week. Yields on Treasury securities fell midweek on weak economic reports and cautious congressional testimony by Greenspan.
But they jumped on Friday’s economic news, as well as concern about an expected sharp increase in supply from upcoming Treasury auctions to fund the growing federal deficit. The yield on the benchmark 10-year T-note ended the week at 3.92% -- near the middle of the range in which it has been trading since last fall.
“The bond market has basically been stuck for about eight months,” said Jeffrey Gundlach, manager of the TCW Galileo Total Return Bond fund in Los Angeles.
Stock investors were more upbeat. Stocks have been rallying -- albeit a bit unsteadily at times -- since mid-March. On Friday, the S&P; 500 and the technology-laden Nasdaq composite notched strong gains, capping their third straight winning week. The S&P; 500 has climbed 16.2% from its prewar low March 11, its lowest close since October.
The Fed is unlikely to change interest rates at Tuesday’s meeting, portfolio managers and economists say, although it could hint at a forthcoming cut by focusing on the risks of economic weakness rather than inflation in its carefully chosen commentary.
“I’m inclined to think the Fed sits on its hands and issues a balanced statement,” said Jim Midanek, portfolio manager at Midanek/Pak Advisors in Walnut Creek, Calif.
Along with recent stock market gains and stronger corporate earnings, there are other positive factors that may comfort policymakers and investors.
Oil prices have fallen sharply from their prewar peak, when jitters sent near-term futures to almost $38 a barrel. In Friday’s trading in New York, oil dropped 36 cents to $25.67.
What’s more, the corporate bond market in the U.S. has improved in recent months, giving companies easier access to capital, Gundlach said.
Still, Gundlach acknowledged, “employment continues to be the most glaring problem. The jobless numbers are too high to be consistent with a recovery.”
As economists and investors try to get a fix on the postwar economy, they will be watching the weekly number of initial unemployment claims, which has been running well above the 400,000 level, along with other new data, over the next four to six weeks.
Some economists say the Fed policymakers might trim rates later this spring or during the summer, especially if the economy deteriorates.
“The probability of another Fed cut has increased,” said Sung Won Sohn, chief economist at Wells Fargo & Co. in Minneapolis. “Not only have we lost half a million jobs over the last three months, but a spate of economic numbers has shown weakness. It’s hard to find an area of strength, and on top of that, there is concern about Japanese-style deflation.”
Goldman Sachs & Co. said it expects the Fed to cut rates by half a percentage point by the end of June in an effort to stimulate growth, according to Bloomberg News.
The Fed also has to weigh the effect that further rate cuts would have on the dollar, which last week fell to a four-week low against the euro. One reason for the greenback’s woes: U.S. interest rates are too low to attract foreign investors.
Given those arguments, with mortgage rates falling last week to a one-month low of 5.70%, according to Freddie Mac -- not far from the generational low of 5.61% in mid-March -- those rates may be about as low as they are going to get, Midanek said.
“Why not take advantage of these rates if somebody wants to lend you money for 30 years?” he said. “It’s silly to wait.”
