How Big a Rate Cut?

Fed speakers won't even hint, and that's fueling the guessing game.
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Fed

officials are talking a lot but saying little as investors wager on the outcome of next Tuesday's rate-policy meeting.

Four Fed officials have now spoken publicly since Friday's unexpectedly weak jobs report sent stocks tumbling. While none of the central bankers have made particularly pointed comments about the health of the economy, neither did they dissuade anyone from the notion that the Fed will indeed cut rates.

"If I'm a Fed official, I am not going to make a dramatic statement one way or the other now," says Ethan Harris, chief economist at Lehman Brothers. "I don't want to front-run my colleagues. I want to get in the room with them next week and debate at the meeting. I'd stick to the party line -- we have a bias to ease, but we haven't made up our minds."

The markets are currently pricing in at least a 25-basis-point cut in the fed funds rate at the Federal Reserve Open Market Committee meeting Sept. 18. The fed funds rate is the rate banks use to lend to each other in overnight money markets. The central bank has kept the fed funds rate at 5.25% for over a year, saying preventing inflation is its main focus.

Since the housing recession melted into a full-blown credit crisis this summer, taking down stocks ranging from

Countrywide

(CFC)

to

Bear Stearns

(BSC)

, some investors have been calling for the Fed to change its tune and ease rates. But it wasn't until last Friday's weak payrolls report that investors really believed the Fed would cut rates.

Since then, Philadelphia Federal Reserve President Charles Plosser and Atlanta Federal Reserve President Dennis Lockhart made noncomittal speeches. Plosser said in a speech in Waikoloa, Hawaii, on Sunday that while Friday's report that the U.S. economy lost 4,000 jobs in August "certainly wasn't good news," he still has "not made up his mind at all" about cutting the fed funds rate. Plosser is a nonvoting member of the Federal Open Market Committee.

Plosser said there is "considerable uncertainty" about the strength of the economic outlook, but he urged caution about relying too much on the jobs report to determine monetary policy. He was reluctant to say the recent financial turmoil and housing market declines had spilled over meaningfully into the rest of the economy. There is still "underlying stability" in the U.S., he said, and noted that blows like Hurricane Katrina and oil price spikes have not always led to major economic downturns. Plosser also said the outlook for inflation was "up in the air."

Monday morning, Lockhart said he is "processing" the information that came out of Friday's jobs report. In a speech in Atlanta, Lockhart emphasized that Friday's data not only reflected a poor labor market in August, but it also "shows that employment was beginning to soften back in June, and that this news should be evaluated with recently positive reports on retail sales."

Only last Thursday, Lockhart had said evidence of an economic slowdown beyond the housing market was not "conclusive." Lockhart will not be a voting member on the FOMC until 2009.

Later Monday, San Francisco Federal Reserve President Janet Yellen disappointed traders by sounding her own cautious note about rate cuts. Those hoping for a 50-basis-point fed funds rate cut were watching Yellen for signs that she'd be pushing for such an outcome. They got anything but that.

After outlining her understanding of the credit crunch that has gripped global financial markets, she acknowledged there is "significant downward pressure" in the economy. But she added that a fed funds rate cut would not be a "panacea" for the markets' problems.

Some observers said Yellen's comments were notable because of their implicit caution about what the Fed can and can't do with monetary policy.

"Yellen's seemingly nay stance to a 50 basis point cut is evident," writes Tony Crescenzi, fixed income strategist at Miller Tabak. "'Panacea' has become a watchword at the Fed, which has come to mean that the Fed can't do much about the dilemma over how to value risks of certain securities, particularly those with mortgage-related exposure."

Dallas Federal Reserve President Richard Fisher said the economy is "weathering the storm," which traders met with some incredulity. He also highlighted the so-called moral hazard of cutting rates to "protect specific risk takers."

Fed Chairman Ben Bernanke is the last Fed head due to speak before next Tuesday's FOMC meeting. His speech is scheduled for 11 a.m. Tuesday.

As the clock to next Tuesday counts down, perhaps it will be a former Fed official who will have the market's ear. Ex-Chairman Alan Greenspan is due to appear on

60 Minutes

this coming Sunday. His book

The Age of Turbulence

comes out next Monday, the day before the FOMC meeting.

His comments this year in his new role as consultant have certainly been headline-making, if not always market-moving. Just last week he said the current crisis was similar to that of 1998, when Russia defaulted on its debt and Long Term Capital Management collapsed. He also compared the current crisis to the stock market crash of 1987. Back in February, Greenspan sent stocks tumbling by saying there was a one in three chance the economy was headed for a recession.

Greenspan said last month in his first and apparently only blog entry on Amazon.com that writing his book was huge because "I could finally use my own voice!"

For better or worse, the markets are still listening.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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