Consensus on the FOMC? Since When? - TheStreet

Once again, Wall Street forecasters are united on the question of what's likely to happen at the Federal Open Market Committee meeting that started Tuesday and will conclude today: The Fed's monetary policy committee will leave the target fed funds rate unchanged at 6.5%, in deference to recent economic reports suggesting that growth finally has started to slow, economists at all 29 primary dealer firms are predicting.

They didn't start out as a united front.

The last time the FOMC hiked rates, May 16, it lifted the fed funds rate by 50 basis points, its first rate action of more than 25 basis points in more than five years. That hike was the sixth since last June, when the key short-term lending rate stood at 4.75%.

The May 16 hike was widely expected. But at the same time, Wall Street was widely convinced the June meeting would pile another 25-basis-point rate hike on top of the 50-basis-point hike expected for May. An additional 25-basis-point move to 7% on Aug. 22 was also seen as a more-or-less foregone conclusion. These charts, which illustrate the odds implied by the prices of

fed funds futures contracts listed on the

Chicago Board of Trade

, show the high degree of certainty on these points that had developed by mid-May.

Odds of June Hike
The chances implied by futures prices of the FOMC raising the fed funds rate to 6.75% in June

Source: Chicago Board of Trade

Odds of an August Hike
The chances implied by futures prices of the FOMC raising the fed funds rate in August

Source: Chicago Board of Trade

Why? It started to build in late April, with strong readings on

consumer confidence and

existing home sales in spite of rising interest rates and a struggling stock market (point 1 on the charts). Upside surprises from the first-quarter

Employment Cost Index and

GDP reports April 27 (point 2 on the charts) spurred additional calls for more rate hikes.

On May 5 (point 3 on the charts), the April

employment report calculated a drop in the unemployment rate to 3.9%, the lowest since January 1970. Investors fretted that tight labor markets would put upward pressure on wages, and they further upgraded the chances the Fed would act to prevent that. Rate-hike fears peaked shortly after the May 16 meeting itself (point 4 on the charts).

There were dissenters, to be sure. As they

told us at the time, they thought the FOMC would pause in June because historically, the committee has normally paused after hiking rates by a larger-than-normal increment. It would do so again this time, the dissenters said, to give the May hike some time to work its magic on the economy.

Jobs and Sales Get Everyone in Line

What brought the rest of the gang into the no-hike-in-June camp? The key event was the June 2 release of the May

employment report (point 5 on the charts), which singlehandedly dropped the odds of a June rate hike implied by futures prices from nearly 100% to less than 50%. While widely interpreted as having overstated the economy's weakness in May, the jobs report detected the first drop in private-sector payrolls since 1996, and the largest one since 1990.

On June 13 (point 6 on the charts), the May

retail sales report detected the second decline in a row, something that hadn't happened in over a year.

Those two reports -- and a few other, lower-profile ones -- made investors willing to believe the Fed's medicine has begun to work. That economic growth has begun to slow. Because inflation is still reasonably well-contained, the FOMC

can

pause while it waits for more economic data, and it

should

pause, forecasters say, in case the next round shows that additional tightening isn't necessary.

The fact that almost all market participants now expect the FOMC to stand pat is yet another reason why it probably will, says Ian Shepherdson, chief U.S. economist at

High Frequency Economics

. "It has not been

Fed Chairman Alan Greenspan's style in recent years to spring unpleasant surprises on the markets," Shepherdson wrote to clients. "He has preferred to build credibility by laying careful groundwork before taking action."

Watch for the Warning

Most forecasters also agree that the FOMC is likely to temper the markets' enthusiasm about a pass on interest rates by continuing to maintain, in its statement this afternoon announcing its decision, that it sees the risks to the economy as "weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future." Such a statement would indicate an inclination to raise the fed funds rate at a future meeting.

Even if the May 16 rate hike turns out to be the last of the cycle, a warning about inflation will serve the purpose of keeping the financial markets from rallying -- a development with the potential to stimulate growth, forecasters say. "Any softer wording would be taken as a green light in the stock market," Shepherdson writes. "This is not the signal the Fed wants to send: We think FOMC members are quite happy with the stagnation in the stock market, and would probably like it to persist for some time."

At the same time, it is likely that the committee will want to hike again come August, many believe. "We are not persuaded -- and we do not think a majority of Fed officials is persuaded -- that the task of containing an incipient inflation threat is complete,"

Salomon Smith Barney's

economists write in their latest weekly report.

Not only are the signs of a slowdown too few, they are also inherently suspect because they arrived during the second quarter, notes

PaineWebber

chief economist Maury Harris. Growth slowed sharply during the second quarters of the last two years as well, only to come roaring back during the third and final quarters. (

TheStreet.com

examined this phenomenon in a recent

story.)

Finally, oil prices have risen sharply in recent weeks, threatening to lead to inflation more broadly in future months.

A few dare to suggest that the FOMC is finished with this hiking cycle. But most expect some additional action by the Fed. The most popular forecast calls for a 25-basis-point hike, to 6.75%, at the committee's next meeting, Aug. 22. A handful think the FOMC will reprise its May 16 move and bump up the key short-term lending rate to 7% on that day. And a few raise the possibility that the fed funds rate could go even higher than that before it goes lower.

Then again, just a handful of weeks ago, most people expected additional action by the Fed in June.