---- by Christopher Anstey ----
WASHINGTON (AFX) - The Federal Open Market Committee (FOMC) will ease interest rates by 50 basis points at tomorrow's meeting, analysts said, predicting the key federal funds rate target will bottom at 2.0 pct by the year's end.
"The Fed will try to be the umbrella in a hailstorm," said Diane Swonk, chief economist at Bank One.
A large majority of analysts contacted by AFX News predicted the FOMC will cut the federal funds rate target to 2.5 pct from 3.0 pct, for the ninth interest rate cut since the easing cycle began in January.
This would be the lowest federal funds rate since the Fed began using interest rate targeting as its key policy tool in the 1980s. Given widespread expectations that the US has slipped into a recession, the Fed needs to show that they have "committed themselves," and avoid the "risk of being seen as returning to a policy of gradualism," said Wayne Ayers, chief economist at FleetBoston. An "overwhelming majority" of National Association of Business Economics (NABE) economists predicted a recession, in a special survey done after the Sept 11 attacks.
After five half-point cuts in the federal funds rate through May, the FOMC turned to a more gradual approach in its June and August meetings, waiting to see the impact of its previous efforts. It returned to a more aggressive approach after the Sept 11 terrorist attacks on New York and Washington to underpin financial markets, easing by 50 basis points a little over an hour before New York equity markets restarted trading on Sept 17.
The Fed injected so much liquidity into overnight money markets that the federal funds rate some days in mid-September fell below 2.0 pct, but has now stabilised around the FOMC's target.
Analysts said such decisiveness is still needed in order to provide a floor for consumer and business confidence, which has been badly affected by the terrorist attacks and expectations of a recession. The Conference Board's consumer confidence index for September fell to 97.6 from 114.0 in August, with the 16.4 point decline representing the index's largest monthly decline since Oct 1990. "The Fed is concerned about...being decisive right now to shore up confidence," Swonk observed.
Sung Won Sohn, chief economist at Wells Fargo, stated the Fed's "primary purpose is really to boost confidence."
Analysts said the Fed's rate cuts will also make a real difference in providing incentives for investors to put money in riskier assets, such as fixed-income securities, which lowers the cost of capital. While the Fed's action will not be able to avert a recession, James Glassman, senior economist at Chase Manhattan, explained that Fed policy "protects against a worse situation."
"You'll never know" the extent to which the Fed's action has supported the economy, "but it would be dragging the economy" down further without continued aggressive rate cuts, Glassman said. Gary Thayer, senior economist at AG Edwards, said the Fed's action can influence "what kind of a recession we have" in terms of length and depth.
Most analysts said the federal funds rate is likely to go to 2.0 pct by the end of the year, with two further cuts, of 25 basis points, at the November and December FOMC meetings.
This would represent a real rate of zero, after accounting for inflation, which is about where the federal funds rate bottomed during the last recession in the early 1990s, analysts said.
With a large fiscal stimulus underway, and continued softness in energy prices, economists said the Fed's action will combine to help the economy turn around by the first quarter of next year.
Neil Soss, chief economist at CS First Boston, concluded that with a federal funds rate going to 2.0 pct by year's end, "fiscal stimulus, declining oil prices, a lot of inventory already being liquidated, and banks in strong shape, we see a recovery starting in the first quarter." A small number of analysts believe the FOMC will only cut by 25 basis points tomorrow, given that the federal funds rate has now already been lowered by 3.5 percentage points, and at 3.0 pct, the Fed could be running out of room for further easing. Henry Willmore, senior economist at Barclays Capital Markets, forecast a 25 basis point easing, on the basis that "they've already done a lot." Alice Rivlin, former Vice Chairman of the Fed, said last Wednesday: "they do have to begin to worry about running out of room." "We're not in the Bank of Japan's (BoJ) situation yet, but the Fed has to begin worrying about how fast they want to move interest rates down, so that they preserve...ability to keep lowering longer." The BoJ has sent overnight interest rates to zero, yet the Japanese economy has failed to revive, now slipping according to many observers into its fourth recession in the past decade. Rivlin added that she would have voted for a smaller 25 basis point rate cut if still on the Federal Reserve Board. But other economists said the example of Japan only shows greater need to act more decisively, sooner. Soss said "if there are any lessons from Japan's (experience), when you have big problems you need to give big medicine, as early as you can." The Fed still would have "250 bullets" to use after tomorrow's expected move, Swonk added, leaving sufficient room to maneuver if needed. Ian Morris, economist at HSBC, said the federal funds rate indeed could go below 2 pct if US equity markets decline another 15-20 pct from current levels. Sohn at Wells Fargo said "the BoJ is in a vastly different situation," where "bureaucrats don't allow market mechanisms to drive supply and demand," and where fiscal stimulus packages have been "wasted." Japan's spending packages have concentrated on public works spending, whereas the US Congress is likely to approve in coming weeks a fresh stimulus package of over 50 bln usd that concentrates on a variety of tax cuts, analysts said. However, Mike Carey, economist at Credit Lyonnais, said the FOMC statement tomorrow "might have something to help assuage concerns that may be at the long end (of the bond market) about the Fed overdoing it." Analysts expect the FOMC to maintain its easing bias in tomorrow's statement, by maintaining its assessment that the risks remain weighted towards economic weakness. Swonk at Bank One concluded that the statement is likely to be short, "clear, and concise," in order to portray a decisive move, and to avoid "over-interpretation" by the markets.