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Market's Atwitter, but Don't Expect the Fed to Ease Now

The FOMC won't ease just to bail out the markets, so chances are good that it will stand pat till its meeting late this month.

If nothing else, today's

Purchasing Managers' Index

put the prospect of the

Federal Open Market Committee

cutting rates before it meets at the end of the month firmly into the realm of possibility.

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The most recent sign that the economy is quickly losing steam, the headline number on the index -- a survey of purchasing executives at roughly 300 industrial companies -- came in at 43.7, its lowest level since the last recession and well below the forecast 47. Any number below 50 on the index signals economic contraction.

The benchmark 10-year Treasury rallied on the report, sending its yield below 5% for the first time since February 1999. Short-term paper, like LIBOR and eurodollar contracts, rallied sharply on the market's belief that the Fed may need to move aggressively. The odds of a quarter-point cut, as implied by the prices of fed funds futures, rose to 55% today from 22% on Friday.

"The economy is skirting recession, based on this data," said Tony Crescenzi,

Miller Tabak

chief bond market strategist, about the Purchasing Managers' report. "This means the Fed has to act sooner rather than later. And the markets are clearly sending a signal of the need for a rate cut."

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But in expecting the Fed to cut rates intermeeting -- even with the mounting evidence that the economy could be heading for the skids -- the market may be overstepping.

"To the extent that the data has weakened, that would more likely lead the Fed to a bigger move, rather than an intermeeting move," says

J.P. Morgan

financial economist (and Fed watcher) Marc Wanshel. "An intermeeting move leads to questions of whether there's a crisis going on. Barring something much worse than what we're seeing right now, the Fed doesn't want to do that."

Since moving to regular meetings, the Fed has moved intermeeting on rates just once, in the fall of 1998, when there were serious concerns that fallout from the Russian debt crisis would lead to a world financial meltdown. That certainly doesn't preclude the Fed from acting between meetings now. Arguably, the last time the economy was slowing like this was in the early 1990s, before Fed gatherings were scheduled affairs.

But it does set a sort of framework for moving between meetings. Such a cut would be more about shoring up confidence than anything else: Fed moves work with a lag on the economy, and the difference between moving now and moving in four weeks is negligible. "You need more of a crisis than you've got for that," says

Bank One

deputy chief economist Diane Swonk. "The Fed is very cautious on this issue of moral hazard -- not to ease just to save financial markets."

Despite such objections, others caution against rejecting out of hand the idea that the Fed could go intermeeting. That the market is pricing in the possibility of such a move says something -- not just to you, not just to me, but to the Fed itself.

"The Fed does have a history of following the market, particularly when things are this volatile," notes

Credit Suisse

economist Mike Cloherty. "They're always worried about disappointing the market. If you get enough priced in, it makes it a little more likely they would go."