Fed seen as likely to act moderately
Despite a bad job report, jitters on Wall Street and a housing slump that could cause a recession in states such as California, Federal Reserve Chairman Ben S. Bernanke and a number of Fed policymakers appear deeply reluctant to try to jolt the economy by aggressively cutting the central bank’s key short-term interest rate.
Although there’s a chance they’ll pare the federal funds rate by half a point, economists and longtime Fed watchers say the odds are that when the central bank’s Federal Open Market Committee meets Tuesday, it will trim only a quarter-point from the rate, which now stands at 5.25%.
Lowering the rate would reduce borrowing costs on mortgages and other consumer and corporate loans, which in turn could lift the economy.
Among the reasons for the Fed’s caution:
* The economy, aside from housing and related woes in the financial sector, continues to show moderate strength, and too sudden a move could touch off inflation.
* The sub-prime mortgage trouble that rocked financial markets this summer is not easily fixed by rate cuts.
* The Fed does not want to use large amounts of its rate-cutting ammunition all at once.
“I don’t think there’s the sentiment on the committee for a big cut right now,” said Lyle Gramley, a former Fed governor now with the Stanford Washington Research Group in Washington. “They will wait for better evidence of spillover [from the housing slump] before they cut more.”
The forecast that the Fed will cut a quarter of a point, widely shared among economists interviewed in recent days, represents a shift from just a week ago, when news that the nation’s job base had shrunk for the first time in four years convinced many that the way had been cleared for the Fed to change course and slash rates to stave off a downturn.
Record exports, a week of rising stock prices and early signs that frightened credit markets were beginning to function again contributed to the change in view.
A modest rate cut could be a disappointment for California, which is now learning how dependent its economy had become on housing.
Last month, home sales in most Southern California neighborhoods plunged 36% from a year ago to a 15-year low for August. Meanwhile, a new estimate by the California Budget Project found that nearly 60% of the jobs added in the state from 2000 to 2005 were housing-related.
“In the wake of the tech collapse of 2000, housing stepped in to carry job growth in the state,” said Jean Ross, executive director of the economic watchdog group. Job growth has slowed in the last year, since housing-related industries began cutting jobs, Ross said.
A quarter-point cut also is likely to disappoint financial markets. Many investors are expecting a half-point reduction, and there could be serious selling if that doesn’t happen. “We’ve already had disruptions in the sub-prime market and the commercial paper market,” which deals in corporate IOUs, said Rob Parenteau, chief economist with RCM Capital Management in San Francisco. “The last thing the Fed needs is a big disruption in the stock market.”
Analysts say the best reason to cut rates is to make a preemptive move against recession. Slumping housing prices will eventually discourage people from consuming, this argument goes, and the central bank should get ahead of the curve. With inflation hovering at just over 2%, there is little danger of setting off a price spiral.
The problem with this argument is that outside previously red-hot markets such as California, Arizona, Nevada, Florida and New Jersey, house prices, while slowing, have continued to rise. The government’s index of home prices rose 0.1% during the second quarter of this year, the latest period for which figures are available, and is up 3.2% over the previous year.
That doesn’t mean the housing market isn’t weakening, but it does suggest that the idea that collapsing house prices will drive consumers away from the malls this fall may be overstated.
The wider economy, though not booming, is not cratering either. Figures issued by the Commerce Department on Friday showed that retail sales rose 0.3% last month, not as much as Wall Street had hoped, but up nevertheless. Most of the difference between actual and expected sales was the result of falling gasoline sales, which was largely the product of declining gas prices, a plus for consumers.
Moreover, Bernanke has repeatedly indicated that interest rates should not be cut simply to reassure financial markets. Indeed, the Fed chairman has distinguished himself from his predecessor, Alan Greenspan, in paying comparatively little attention to financial markets in making interest-rate decisions and has sought other means to respond to market disruptions.
In an unusual move Aug. 17, the Fed lowered its “discount rate” from 6.25% to 5.75% and invited banks to borrow at its discount window.
Daily borrowing in the few days before its announcement was a minuscule $4 million. Borrowing on Wednesday, the latest day for which figures are available, amounted to $7.15 billion.
More recently, the Fed took the unusual step of joining other federal bank regulatory agencies in encouraging mortgage lenders to give breaks to borrowers who are likely to default on their loans. They suggested remedies such as “deferral of payments, extension of loan maturities, conversion of adjustable-rate mortgages into fixed rate . . . [and] capitalization of delinquent amounts.”
By using these techniques, Bernanke appears to be trying to come up with solutions that go directly to the problem area. In the case of the discount window, it was banks that were unable to borrow because of the credit market freeze. With mortgage forbearance, it was to aid homeowners, especially those who may be about to lose their houses. These tactics are more targeted than using the blunt instrument of interest-rate cuts to goose the economy.
Just getting to Tuesday’s meeting represents something of a triumph for Bernanke. It demonstrates that the Fed has avoided making an emergency rate cut between meetings. At several points in the last month, it appeared that such a move would be almost forced upon the central bank.
In mid-August, the Fed made an about-face from its view that the biggest danger to the economy was inflation, not a slowdown. The policymaking panel said it “judges that the downside risks to growth have increased appreciably. The committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.”
Those strong words have buoyed spirits and given rise to big bets that the Fed will do some cutting come Tuesday.
--
