It took some time, but now pretty much everybody is on the same page: When the Federal Open Market Committee concludes its two-day meeting Wednesday, it will, for the first time since last January, leave the fed funds target unchanged.
Until late last week, this outcome was anything but certain. Around midmonth, after all,
Chairman Alan Greenspan made a pessimistic-sounding speech that seemed to foreshadow a 12th-straight rate cut. Futures markets started betting the
fed funds rate would fall from its current 1.75%.
But Thursday the chairman
took a far more bullish view, explaining to Congress that he'd been misinterpreted. So now, two months after the recession officially started, Wall Streeters eagerly agree that the economy is ready to grow again. As a result, the big question surrounding the two-day meeting is how long the Fed will wait to reverse its long easing trend.
There is a difference, of course, between the road to Wellville and Wellville itself. Even if the FOMC has finished cutting rates, which is far from certain, that doesn't mean it's going to start raising rates in the near future. Underscoring that point, when the committee concludes its meeting Wednesday, it will in all likelihood say that the risks for the economy remain tilted toward weakness.
"They will probably want to see the economy on firmer ground before they start to move or talk publicly about the need to move," says Morgan Stanley chief U.S. economist Richard Berner. "They'll want to leave their options open."
That's because the big worry about the current recovery, Berner's colleague Steve Roach notes, is that it will falter and the economy will see a "double dip." The first stage of a classic recovery comes from inventory rebuilding among companies that have depleted their stocks.
This stepped-up production kick-starts the economy out of recession. But for recovery to be sustained, demand must pick up, too. People worrying about their jobs must feel more secure about their futures and resume spending. Companies, also, must shift from belt-tightening to hiring workers and buying new gear.
The problem this time around is that because consumer spending never plunged during the brief recession, it may not spring back sharply, either. And companies went on such a capital-equipment buying spree toward the end of the last expansion that they may not need much new gear for a while.
"You need final demand to kick in," says Salomon Smith Barney economist Mitchell Held. "The Fed will be looking to see if consumer spending and housing maintain their strength."
That said, most economists seem to agree that rates can't stay this low for long. Held, for one, doubts that the Fed will raise rates by much this year: Inflation is subdued, and Greenspan's recent remarks suggest he remains a true believer on the productivity miracle (that there's been a secular increase in productivity that diminishes inflationary pressures). Even so, the Salomon forecast, which has the funds rate staying where it is through midyear, projects a rise of 75 basis points, to 2.5%, by year-end.
That's a relatively dovish view, alas. Berner also sees the funds rate unmoved at midyear, but expects it to have jumped to 3.5% by year-end. He thinks the Fed's idea of an equilibrium funds rate "has a four in front of it," and that the board will move in that direction well in front of any inflation signal. "The notion that the Fed has to have a trigger to tighten monetary policy is just plain wrong," he says.
Uncertainty may well be the common denominator when it comes to these forecasts. Northern Trust's Paul Kasriel, an economist who is often critical of the Fed, finds himself in the uncomfortable position of agreeing with the consensus view that the Fed isn't going to be hiking rates anytime soon. "I'm forecasting a fairly moderate recovery," he says. "Of course, everyone else is too, which is a compelling argument that it will be stronger."
Kasriel notes that money supply has been growing strongly, and that portends a strong recovery. So, too, does the spread between short- and long-dated Treasuries, or the
yield curve. In fact, the difference between the two- and 10-year Treasury yields is the widest it's been in nine years -- an indication that the market is expecting a robust recovery.
Nor is that the only signal the market is sending that things may be stronger than the average economist or the Fed expects. The fed funds futures market has fully priced in a quarter-point hike from the central bank by midyear, with a 60% chance that the funds rate will be a half-point higher by then. While this is by no means a guarantee that the Fed will be hiking rates by then, says Jim Bianco, president of Bianco Research, it's a good indication of where the odds lie.
Bianco is of the view that the Fed, and specifically Greenspan, basically does what the market tells it to do. Regardless of what economists tell you, he says, if we get on toward April or so and the futures are still pointing toward a midyear hike, get ready. "Whenever the market taps him on the shoulder and tells him it's time to tighten," says Bianco, "he will do it."