When it comes to rate cuts, there's likely more yet to come.
Economists interviewed after the
Federal Reserve cut short-term interest rates by a quarter-percentage point Wednesday afternoon said they expect the Fed will again be in rate-cutting mode later this summer. The Fed's latest decision puts the fed funds rate at 3.75%. When the year began -- and before the Fed had made six reductions -- rates were at 6.5%.
senior economist Gerald Cohen and Bruce Kasman, chief U.S. economist at
Federal Open Market Committee will cut rates by at least another 25 basis points. Ahead of today's Fed meeting, 15 of 25 primary dealers in government securities, including Merrill and Morgan, were betting the Fed would cut by 50 basis points today.
TSC: Was there any piece of data that had a greater impact on the FOMC decision?
No. We had moved from 25 to 50 because we felt there was enough data to support the view that they'd go 50. In their statement, they could have said something about how the housing sector and consumer spending continues to be OK. But they talked about a lot of weakness. So that's what's a little confusing to me. So the statement is uniformly weak.
TSC: Does the decision suggest any concern over inflation? In its statement about the rate cut, the Fed said: "The associated easing of pressures on labor and product markets are expected to keep inflation contained."
I think the statement about inflation is an important one. We are not at all concerned about inflation, but there may be
Fed governors out there who are. But we're not at all concerned.
TSC: What kind of future rate cut does the language in the statement suggest? The Fed said: "The patterns evident in recent months -- declining profitability and business capital spending, weak expansion of consumption, and slowing growth abroad -- continue to weigh on the economy."
We are looking for another 25 basis points. Given the time span between this meeting and the next -- two months -- we wouldn't rule out an intermeeting move, but I think the probability of that is still low.
TSC: Considering the typical six-month lag, do you expect to see some important signs in July that this year's rate cuts are beginning to have an impact?
I would say six to nine months at a minimum. We think the economy will start to rebound in the third quarter. I think you won't start to see signs until the very end of the third quarter.
TSC: What kinds of signs?
Flat to positive job growth rather than flat to negative job growth; consumer spending starting to show signs of a little bit of pickup; maybe the industrial sector not declining; consumer confidence starting to rise; the index of leading indicators starting to rise. Job markets not deteriorating is a very important one.
TSC: The Fed's statement was less optimistic on the economy this time around than it was in May. Why did the committee cut by just 25 basis points, if it sees more weakness?
I think it was a tactical decision. I think they are clearly not showing any greater optimism on the economy, but they are emphasizing in the move that they have moved 275 basis points now, and they're willing to move a little more slowly in hopes that the lags in the policy transmission mechanism work. It was a tactical decision.
It may very well be that there was a disagreement in the committee. You never know that till long after. But this may have been a compromise between those that wanted to move more aggressively and were more concerned about the economy and those that were more upbeat. That's a possibility.
But whatever the underlying interpretation, they're moving more gradually, but they're not changing their reading on the economy in any meaningful way.
TSC: What do you expect in terms of future interest rate cuts?
We have one more in August of 25
basis points, and that's it. Conditional, of course, on the recovery starting to take hold in the third quarter. Which I think right now remains an event that is forecasted, but doesn't have any real clear evidence to support it.
TSC: What kinds of signs do you expect to see then and when?
I think if you get a recovery in the third quarter, you have to see some signs play out over the third quarter, from now through the end of July and early August. Jobless claims have to start showing signs of moving downwards. You need to see signs that consumer spending is actually moving up a bit, see signs that the capital goods side of the equation is showing less weakness. And I think you need to see the National Purchasing Managers' Index move upwards in a fairly significant fashion in the next few months. A 42 level is consistent with recovery.
TSC: What if that doesn't happen?
Depending on the degree of disappointment there, it could mean that we're stuck in a very low growth path or that we've actually slid into recession, because the second quarter is a negative quarter in our judgment. So, if you don't get any of those things happening, then you're probably in a recession. If you get a mixture of things, then it's possible all you're doing is languishing at a very low positive growth rate.
TSC: Do you think the Fed could be forced to raise interest rates later this year if the economy actually does pick up substantially?
I would not think that a rate hike this year is a reasonable scenario to look at. I do think that if we get a clear-cut recovery in the second half of this year, then you can think about the Fed tightening next year, in the spring or midyear. But it's way too soon to be thinking about in this economy. The inflation picture is looking OK. There's a lot of excess capacity out there right now. Energy prices are coming off. I don't think inflation is a real issue right now.