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On the Fed's Far Horizon, Perhaps an Ease

To a man, economists say the


won't raise rates tomorrow. Well, no kidding.

Until the past few weeks, many an economist would have answered "not a chance" when queried on the possibility that the

Federal Open Market Committee

could conceivably ease the federal funds rate, currently 5.50%. But the picture for the August and September meetings is cloudier.

Continued weakness in Asian economies is tempering the growth in U.S. manufacturing and exports, despite strength in other facets of the U.S. economy. The overall effect, however, is still somewhat nebulous.

"We would have felt the chance of the next change toward ease as being zero," said William Sullivan, director of money market research at

Morgan Stanley Dean Witter

. "Now, I think that you have to assign some probability that a convergence of events could come into play that eventually prompts the Fed to lower the federal funds target, perhaps in early 1999."

But a still-likely scenario, after this long period of stability in monetary policy, is that a muted reaction by the U.S. economy to Asia's impact -- which some still term unquantifiable -- and tightness in the labor market could give rise to greater inflationary pressures.

"The size and timing of the negative impact has been later and significantly lighter than anybody had anticipated," said Barbara Kenworthy, portfolio manager at

Prudential Investments

. "We still all question, 'Is there going to be an impact, and how big?' The economic growth continues to be significantly higher than a noninflationary rate of growth. There's continued problems in Russia, Southeast Asia and also Japan. Right now the Fed has to look more carefully at the international side."

Economists said

Alan Greenspan

and his cohorts are essentially playing the Asian situation off the U.S. economy as the rationale for leaving rates unchanged.

"Greenspan and the others have placed a bet that Asia would slow the U.S. economy, and that's a good bet to have made," said David Blitzer, vice president and senior economist at

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Standard & Poor's

. "Asia's impact is beginning to be shown in the trade data and big inventory buildup."

On a year-over-year basis, exports to the Pacific Rim have declined 13%, versus a 5% decline in exports to Europe and gains in exports to Mexico, South America and Canada. Sullivan said if the trade gap continues to widen, coupled with the accumulation of inventories, it could cause layoffs in the manufacturing sector. In turn, according to his scenario, this could lead to a reduction in price pressures.

"With jobless numbers creeping up, not down, and a softening of industrial production, all with the maintaining of a strong dollar, tells me the Fed is in the position to drop the funds rate," Sullivan said.

Also contributing to the slowdown is the decrease in durable goods orders. Sales fell 2.6% in May in several different sectors. By contrast, the real estate market is at its most robust, and the first-quarter

gross domestic product

was revised to 5.4%, much higher than expected.

In terms of dissecting this data, Kenworthy suggested the June

employment report

, scheduled for release Thursday, as a barometer. Despite whatever influence Asia has on the Fed, if average hourly wages jump, Kenworthy said, "that's going to be very worrisome. The good news is the

employment cost index numbers have been better than we've been looking for, with lesser increases" in nonfarm payrolls.

The wrench in this giant machine is the

General Motors

(GM) - Get General Motors Company (GM) Report

strike. The outcome here, if labor succeeds against the auto manufacturer, would be to increase employment costs -- more evidence in favor of a hike.

"If the company caves and gives a lot to labor, then employment costs tick higher, and that would be a benchmark event," Kenworthy said. "But GM holding firm is probably good news for the labor front."

With no immediate end to the strike in sight, Sullivan said a near-term change in lending rates is unlikely.

"When they meet in August it will be against the backdrop of the restraining influence due to this strike, which is more widespread and deeper in impact than we actually thought it would be," Sullivan said.