The Fed :" Damned if you do, damned if you don't"

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FED’S NOT COMING TO THE RESCUE THIS TIME By JOHN CRUDELE --------------------------------------------------------------------------------

May 15, 2001 -- CHOOSE your poison.

The Federal Reserve Board will meet today to decide what to do about interest rates. And while experts have made a sport out of batting around opinions on how big the next rate cut might be, the decision in reality is incredibly difficult and unbelievably dangerous.

Here's the predicament.

Two weeks ago the smart money was on a half-percent rate cut. Those of us who understand just how weak the

economy really is even felt that a three-quarter point cut (75 basis points in the lingo of the Fed) might be in store.

But this is a game where the rules change almost every day.

The half- to three-quarter point guesses were made right after Washington announced that 223,000 jobs were lost in April. At that point in time, Wall Street had finally come around to the very logical opinion that the economy was sinking fast.

In a bit of unexpected candor, the White House even solidified that view by saying that the earlier reported 2 percent gain in the nation's first-quarter gross domestic product probably wasn't valid.

But the rules suddenly changed last week when it was reported from various sources that producer inflation rose only 0.3 percent in April, consumer confidence had improved and that retail sales in the latest month weren't as lousy as many people expected.

None of these stats really contradicts the idea that the economy is weak and inflation is rising.

Retail sales improved last month, but the results from the two previous months were adjusted downward. And consumers are usually only as confident as the stuff they read in the newspaper and hear on the news, which

has been getting more upbeat after numerous interest rate cuts and another on the way.

Even the producer inflation number was suspicious. The government sees hardly any energy inflation this year; does that sound right?

Even if the suddenly upbeat economic news seems wacky to you and me, Wall Street still trades on the information.

Now I'll get to the dilemma.

The Fed is getting private economic data that says the economy is headed for - or already in - a recession. So Greenspan could decide to ignore the newest government statistics and cut rates by a half-percent.

But if he does that, the bond market will revolt.

Bond prices have collapsed already and sent long-term interest rates sharply higher late last week after those stronger economic numbers I mentioned above were reported. If the Fed looks like it is pumping too much money into the economy and ignoring the inflationary effects, interest rates could go to the monetary moon.

A three-quarter percentage point cut - which is probably needed at this point - is completely out of the question right now.

The Fed could heed the bond market's concerns and take the conservative road by cutting interest rates by only a quarter-point. But that'll probably upset the stock market, which is counting on lower borrowing costs to help companies improve their slumping profits.

If the bond market looks like it is really spooked there is also the possibility that the Fed won't cut rates at all. That is a long shot, and it would have to be done delicately.

The script would go something like this: Greenspan will tell his colleagues that he is worried about long-term rates climbing so quickly and perceptions that the Fed is losing control over borrowing costs.

Publicly, he'll simply say that the 30-percent reduction in the Fed funds rate this year hasn't yet had time to work, so he's holding off on another cut.

And then he would pray that the stock market doesn't collapse.

So, you see, this is one of "the damned if you do, damned if you don't" situations. Hemlock or arsenic? Help stocks and hurt bonds, or hurt bonds and - perhaps - help stocks?

My guess: a quarter-point rate cut and some words of wisdom hinting that the Fed will go slow on future cuts. Bonds will like it, stocks won't. And Wall Street gurus will finally snap out of their trance.

New York City is preparing for a major drop in revenue from Wall Street, I'm told.

A source tells me that the city's Office of Management and Budget - which has to guess at revenue figures in its forecasts - is expecting Wall Street profits to decline 75 percent this year to just $5.5 billion.

Things might not turn out that badly, and Wall Street is telling the city that they won't. But those are the numbers with which the city is prepared to deal, since the financial markets are usually one of the city's strengths.

I'll have more on this in future columns.

OMB says it expects profits to rise to just $10.2 billion in 2002. Wall Street profits in 2000 rose to $21 billion.

Please send e-mail to: jcrudele@nypost.com

http://nypostonline.com/business/30498.htm

-- Martin Thompson (mthom1927@aol.com), May 15, 2001

Answers

FOMC cuts rates by 50 basis points Fed statement signals more rate cuts on the way By Rex Nutting, CBS.MarketWatch.com Last Update: 2:18 PM ET May 15, 2001

WASHINGTON (CBS.MW) -- The Federal Reserve cut overnight interest rates Tuesday and indicated that even lower rates may be needed.

FRONT PAGE NEWS U.S. markets climb after rate cut Retail stocks narrow losses after Fed rate cut

The central bank's Federal Open Market Committee lowered its Fed funds target rate to 4 percent, its fifth half-percentage point cut this year. The discount rate was also dropped by 50 basis points to 3.5 percent on a unanimous vote.

In its statement, the policy-making FOMC said it continued to be worried about slow capital spending, stunted profits, high energy prices and accelerated job layoffs.

"Investment in capital equipment... has continued to decline," the Fed said. "This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, continues to weigh on the economy."

Investors fully anticipated the rate cut. However, there's a growing feeling on Wall Street that the Fed may be near the end of its easing cycle, which has seen the Fed funds rate fall from 6.5 percent at the beginning of the year to 4.0 percent today, a seven-year low. See a history of Fed moves.

The next meeting of the Federal Open Market Committee is scheduled for June 26 and 27.

The Fed funds futures market gives just a 19 percent chance of a 3.75 percent funds rate following the June meeting. Economists surveyed by CBS.MarketWatch.com are forecasting the Fed funds target rate at 3.75 percent in six months.

The Fed funds rate is the interest banks charge each other for overnight loans to help them satisfy the Fed's reserve requirements. The rate heavily influences banks' cost of capital and the growth of money in the economy. Read how the Fed's monetary policy works.

Changes in the Fed funds rate are reflected nearly immediately in the prime lending rate. The interest charged on many credit cards and home equity loans are tied directly to the prime rate.

Many other lending rates, however, are only indirectly affected by the Fed. Home mortgage rates, for example, began falling a year ago in anticipation of the Fed easing rates. Average 30-year mortgage rates, which peaked a year ago at 8.52 percent, bottomed at 6.89 percent on March 22 and have risen about 25 basis points since then. One hundred basis points equal 1 percentage point.

Most corporate borrowing is also linked to longer-term yields, such as 10-year Treasury notes, which have been rising in recent weeks. The average rate for AAA-rated corporate bonds has risen 27 basis points in the past two months.

As for investors, the stock market desperately wants more rate cuts to help revive the economy and corporate earnings. On the other hand, the bond market worries that the Fed has already pumped too much money into the economy and fears that the stimulus from the rate cuts and the coming tax cuts will fan inflationary embers.

Recent evidence shows the economy is weak, although not technically in a recession.

The economy grew at a 2 percent pace in the first quarter, even as factories cut their output at a 7.2 percent rate. Companies let nearly 300,000 workers go in March and April, the biggest round of layoffs since the nation's last recession in the early 1990s.

On the bright side, consumer spending and housing aren't in the dumps -- they're just stagnant. Healthy retail sales in April and a rebound in consumer confidence have fueled hopes that the consumer would remain strong enough to drag the dormant manufacturing sector out of the ditch.

Rex Nutting is Washington bureau chief of CBS.MarketWatch.com.

http://cbs.marketwatch.com/news/story.asp?print=1&guid={AABFEBBC- 8699-4383-AFB3-E452249DC750}&siteid=mktw

-- Martin Thompson (mthom1927@aol.com), May 15, 2001.


The spread between the Fed Funds rate--now 4%--and the 30-year treasury rate--nearly 6%--is too wide. It just can't last.

I knew, last year, when the inverse yield curve hit us, for nearly all of that time, that a recession was coming. It always does shortly following such a freak of financial market interplay.

About all we can do now is prepare, by switching to highly defensive investments--and cross our fingers.

-- JackW (jpayne@webtv.net), May 15, 2001.


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