Fed Expected To Cut Rate Again to 2%!

Submitted by SadInAmerica on Sun, 04/27/2008 - 10:58pm.

Just ahead of a meeting of Federal Reserve policy makers this week, the widely shared consensus is that the Fed will most likely cut its benchmark short-term interest rate to 2 percent from 2.25 percent, signaling that while financial markets have stabilized somewhat, concerns about an U.S. economic downturn remain paramount.

There is always a chance for a surprise, Fed watchers say. But lowering the rate for a seventh time since August would be consistent with comments by Ben Bernanke, the Fed chairman, that a recession was still possible this year and that - as Treasury Secretary Henry Paulson Jr. put it - the risks were to the downside.

But beyond what the Fed does, economists and specialists will be looking for what it says.

Of particular interest is whether the Fed hints that this might be the last rate cut for a while, as many experts think, on the ground that further reductions will fan inflation and send the dollar to new lows.

"I don't think there's any question that they'll cut 25 basis points off the rate," said David Rosenberg, chief North American economist at Merrill Lynch. A basis point is one-hundredth of a percentage point. "The real question is what they say about the future. It won't be an 'all clear' signal. But they'll find a way to tell the markets that they've done enough for now, simply put."

At issue is the meeting Tuesday and Wednesday of the Federal Open Market Committee, the Fed's monetary policy-making panel, which consists of the Fed's board of governors and the presidents of the regional Federal Reserve banks.

A month ago the committee met on the heels of the Fed's stunning participation in the fire sale of the investment bank Bear Stearns to its larger rival JPMorgan Chase, an action that Bernanke defended as necessary to avert turmoil in the financial markets and the possible collapse of financial institutions around the world.

The Fed's involvement came in the form of an emergency $29 billion loan in return for collateral in the form of mortgage-related securities of uncertain value.

It was then that the Fed lowered its federal funds rate - the rate for overnight loans between banks - by three quarters of a percentage point, to 2.25 percent. The Fed, trying to still the chaos in the markets, also left the door open to more rate cuts.

Two members of the committee dissented, however, saying that a smaller rate cut would have been preferable in light of the dangers of inflation. The discord opened an unusual window into the internal debates of the Fed in the era of Bernanke, who has called for more transparency at an institution renowned for its secrecy.

If anything, inflation fears have grown in the past few weeks. Soaring prices for food, oil (which almost reached $120 a barrel last week) and other commodities appear to be as painful for Americans as unemployment and the collapse of the mortgage market. The trends are certain to be a matter of lively discussion this week.

"I think it's going to be a contentious meeting," said Lyle Gramley, a senior adviser at the Stanford Washington Research Group and a former Fed board member. "There are lots of people on the board who have demonstrated they are pretty hawkish on inflation, and developments in the past month have given them ammunition."

It is hardly new for the Fed to be caught in the middle of a quandary between the need to lower rates to stimulate the economy and the need to raise them to ward off inflation.

But added to the concern is the plummeting dollar, which is spurring rising oil prices, since oil is priced in dollars and oil producers are unhappy when cheaper dollars cut into their income. The lower dollar is also leading speculators to buy oil and other commodities, contributing to global spikes in the price of everything from food to gold.

If the Fed does signal a pause in lowering rates, however, it will not be welcome among many who feel that, with problems persisting in the housing sector, the dangers of a deepening slump should be the highest priority.

"It's our core view that financial conditions remain very stressed," said Lewis Alexander, chief economist at Citigroup. "If what the Fed does is interpreted as precluding further action, it's going to hinder recovery of the markets and indicate a more downside risk for the economy."

Like many economists, Alexander said that he did not dismiss the dangers of inflation. But he added, "We are not in a situation where the inflation problem is so bad that the Fed needs to accept a deep and prolonged recession in order to contain it."

One tricky aspect of the Fed's problem is that the impact of whatever it does may not be felt for more than six months. Many economists say it takes at least that long for interest rate cuts to have an economic impact.

Similarly, the Fed may be waiting for the first signs of the impact of the rebate checks to U.S. taxpayers, which the Internal Revenue Service is set to begin mailing on May 9 as part of a $150 billion stimulus package enacted by Congress this year.

"We're at the point in the monetary cycle where there are a wide range of opinions," said Bruce Kasman, chief economist at JPMorgan Chase. "Most likely their statement will reflect both sides of the risk spectrum. Inflation will get its paragraph, but we'll be hearing about an economy that remains quite weak."

Steven Weisman - International Herald Tribune - April 27, 2008 - posted at www.iht.com/articles/2008/04/27/

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Submitted by SadInAmerica on Sun, 04/27/2008 - 10:58pm.