Fed is widely expected to cut key rate
With oil prices stubbornly high and housing prices still skidding down, the Federal Reserve is expected to cut its benchmark interest rate today in hopes of containing the damage from a softening economy.
The troubled housing market is most likely the Fed’s No. 1 concern, analysts say. Foreclosures are rising as more Americans struggle to make higher payments on their adjustable-rate loans, and the full extent of the damage is not yet clear.
“I think housing will have an economywide impact,” said Tracy Clark, an economist with the W.P. Carey School of Business at Arizona State University in Tempe.
“When housing prices were going up, people felt wealthier and they spent some of that perceived wealth. You had people doing refis every six months, and that allowed them to spend a lot more.”
Now consumer spending is slowing, and growth will sink with it, said Scott Anderson, senior economist with Wells Fargo Economics.
“I think it will be a bad retail season. We already see some discounting by retailers in anticipation,” Anderson said. “That’s spillover from the deteriorating housing market.”
Like most economists, Clark and Anderson believe the Fed will cut the key federal funds rate by a quarter of a point, to 4.5%. In September, the Fed made its first rate cut since June 2003 and slashed the federal funds rate by 0.5%, twice the trim most analysts had expected.
But with crude oil trading at near-record highs, Fed governors will still be concerned about the possibility of inflation and will try to be careful not to spur it by lowering interest rates too much.
“We’re expecting a quarter-point cut, but that might be it for a while,” Anderson said.
Crude oil prices streaked to a record-high close of $93.53 a barrel in New York on Monday before falling back Tuesday to $90.13.
Higher oil prices can trigger inflation and also slow consumer spending. As the holiday shopping season approaches, retailers are concerned that higher fuel and heating bills will translate into fewer purchases at the mall.
So far, however, the effect of higher oil prices on the economy has been modest.
“It is surprising to many people that the sky is not falling,” said Mark Vitner, a senior economist at Wachovia Corp. “If you were to have asked economists as a group two years ago, ‘If oil was at $93 a barrel, what would happen to the economy?,’ I think most people would have said we’d be in some serious trouble.”
A growing number of economists have begun to downplay the long-assumed link between high oil prices and recessions.
Fed Chairman Ben S. Bernanke, for example, has written that the recessions in the 1970s, 1980s and 1990s were driven largely by mistakes in monetary policy, not by energy costs, notes Philip K. Verleger Jr., an energy economist and consultant based in Aspen, Colo.
“Oil’s not irrelevant, but it’s pretty small in the picture,” Verleger said. What’s more, he said, “energy’s a much smaller share of the U.S. economy . . . [and] that further reduces the impact higher energy prices have on the economy.”
Less U.S.-based manufacturing, more energy-efficient cars and appliances and a shift away from using oil to produce power and home heating have all helped give the economy greater protection against high oil prices, Verleger and others said.
“A lot of our industry and GDP [gross domestic product] activity is in things that either don’t use oil anymore or are not oil-intensive,” said Amy Myers Jaffe, energy research fellow at Rice University’s James A. Baker III Institute for Public Policy in Houston. “We do a lot of computer and information technology services and a lot of banking and design, and things like that.”
The prices of some oil-dependent products have been gradually heading upward, but the cost of gasoline and diesel -- the lifeblood of goods-laden trains and trucks -- has not yet seen the full effect of $93-a-barrel oil.
“Oil does permeate and flow into all the nooks and crannies of the economy,” said Daniel Yergin, a Pulitzer Prize-winning author and chairman of Cambridge Energy Research Associates. “So if prices remain at this level for a while . . . it will be felt in the price of everything from a gallon of gasoline to the price of food and the price of goods.”
Jaffe at Rice agrees.
“To say that it’s not impacting the U.S. economy, or that oil prices could go up to any level and wouldn’t affect your and my consumer spending, all of that is nonsense,” she said. “The Grim Reaper will eventually hit us. The question is, when would that happen and what is the price?”
For the time being, however, there seems to be a lag. And at least some economists think the economy is so stable that neither oil prices nor housing will sink it.
“In the U.S. economy, the recessions are typically so small that it’s hard to see them coming,” said Lee Ohanian, a professor of economics at UCLA. “Compared to any other economy in the world, the U.S. economy is very, very stable. The wigs and wags are sufficiently small that they are hard to predict.”
elizabeth.douglass@latimes.com
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Reynolds reported from Washington, Douglass from San Diego County.
