Wall Street is looking for a reprieve from the
this time. The only question is whether it will be total or partial.
Each of the last two times the Fed's monetary policy committee has gotten together for its month-and-a-halfly meeting to decide what, if anything, to do about the short-term interest rates it controls, the fed funds rate (the more important one) has wound up higher.
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But when the
Federal Open Market Committee
meets tomorrow, economists and bond traders expect Fed Chairman
and his cohorts will leave the fed funds rate unchanged at 5.25%. A
poll of the 30 primary dealers of Treasury securities found that just one (
) is looking for another 25-basis-point hike this time. Similarly, the fed funds futures contracts listed on the
Chicago Board of Trade
are pricing in just a 21% chance of a rate hike tomorrow.
The reprieve will be only partial, however, if at the same time the FOMC decides to leave the fed funds rate alone, it opts to switch its so-called policy directive -- its view on the likely direction of rates in the future -- from neutral to tightening. Thirteen of the dealers in the
survey are predicting a tightening bias. And there's a third possibility: a bias that isn't really a bias.
November Hike Could Still Lurk
An actual tightening bias would send the message that a third rate hike at the Fed's penultimate meeting of the year, on Nov. 16, is likelier than not. Market watchers earlier this year considered that outcome extremely unlikely because the date is so close to the end of the year, when there might be economic and financial disruptions associated with the millennium date change. Most economists still believe that the Fed's final meeting of the year, on Dec. 21, is extremely unlikely to produce a rate hike for that reason. But the notion that November is off the table has lost favor, in part because Fed Gov.
said on Sept. 2 that Y2K "certainly does not tie the Fed's hands."
Investors on Friday substantially hiked the odds of a tightening bias tomorrow and a rate hike in November, after a key manufacturing indicator -- the
National Association of Purchasing Management's
report -- showed extraordinary strength, particularly in its measure of raw materials prices. The November fed funds futures contract fell sharply, lifting its implied odds of a Nov. 16 rate hike to 99% from 69% the day before.
When it announced its second and most recent rate hike Aug. 24, the FOMC
tossed a big, juicy bone to those who thought October would bring a third one:
"With financial markets functioning more normally, and with persistent strength in domestic demand, foreign economies firming and labor markets remaining very tight, the degree of monetary ease required to address the global financial market turmoil of last fall is no longer consistent with sustained, noninflationary, economic expansion."
The Fed cut rates three times last fall, so a full undoing of that "degree of monetary ease" would require a third hike. In the same breath, though, the committee hinted that a pause was likely. "Today's increase in the federal funds rate, together with the policy action in June and the firming of conditions more generally in U.S. financial markets over recent months, should markedly diminish the risk of rising inflation going forward," it said.
A rate hike isn't expected tomorrow in large measure because the Fed heads haven't prepared the markets for one, as they typically do. In two major speeches prior to the last two FOMC meetings, Greenspan signaled the coming rate hikes.
But in five speeches in September, including two last week, Greenspan avoided any direct mention of the FOMC's near-term agenda, as have other Fed heads. "Just about every FOMC member has had an opportunity to express his or her view on monetary policy and the economy in recent weeks,"
senior economist Henry Willmore wrote in a research note. "They could have used these speeches to prepare the markets for another tightening but chose not to."
Economic Data Aren't Screaming 'Tighten!'
In addition, apart from the NAPM report on Friday, no economic release since the Fed's Aug. 24 meeting has screamed that the Fed should tighten. The August
employment report, released Sept. 3, showed a below-trend rate of payrolls growth and a nonthreatening 0.2% rise in average hourly earnings. And both the
Producer Price Index and the
Consumer Price Index, which measure inflation at the wholesale and consumer levels, rose by modest amounts in August, the government reported in mid-September.
Both the PPI and the CPI are expected to be very strong for September, due in large measure to continuing strength in oil prices and a one-time tobacco price hike. The split over whether the FOMC will adopt a tightening bias tomorrow reflects disagreement over whether the committee is likely to regard these results as outliers.
As for the possibility of a nonbias bias: When it hiked rates in June, the FOMC went to a neutral bias, but in its statement noted the importance of being "especially alert to the emergence, or potential emergence, of inflationary forces that could undermine economic growth."
"This was an effort to acknowledge that further rate hikes were possible without telling the market to price them in with 100% certainty the next day," a research note by
observed. But like a practical joke, it probably won't work more than once, the firm went on. "If a qualified bias in June led to a rate hike in August, the market will be inclined to believe that a similar stance in October implies another tightening in November."