Tuesday, August 22, 2000

Fed's mood as weighty as action

Economists predict rates will stay put

By John J. Byczkowski
The Cincinnati Enquirer

        Economists believe the Federal Reserve Board will stand pat on interest rates today. But what may be more important than interest rate action is what the Fed says about its mood.

        “Here's the thing to watch for: the bias,” said Kenneth Mayland of ClearView Economics in Cleveland.

        He said a change in bias — an indication of the Fed's mood on interest rates — could send the stock market into a strong rally, and bring stronger economic growth.

        There are numerous signs the white-hot consumer spending feared by the Fed is slowing. Auto sales are down, and growth in retail sales has slowed. Mr. Mayland said the decline in new home starts this year equals that of 1994-95, the last time the Fed engineered a “soft landing” in the economy.

        “The evidence is virtually overwhelming that they will not move,” said James Coons, chief economist at Huntington Bank in Columbus. “Retail sales flattened in the spring, housing starts continue to drift downward, and we've gotten good news on the inflation front.”

        Strong growth in productivity allows workers to receive higher wages while their employers hold prices steady. “The very high productivity numbers have essentially been the story of the last year and a half,” said Gregory Hess, an economist at Oberlin College and member of the Fed-watching Shadow Open Market Committee.

        Each Fed meeting brings a statement on interest rates and a statement on bias. After the June 28 meeting, when the Fed left interest rates alone, it said economic conditions “continue to be weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future.”

        That means the Fed sees inflation as a threat, and leans toward raising interest rates, or tightening credit, in the future.

        The news on inflation has been steady: In each of the last four months and in nine of the past 11 months, the core inflation rate rose 0.2 percentage points. “Inflation remains remarkably stable,” Mr. Mayland said.

        Despite the consistency of the last 11 months, the Fed has raised rates four times. Standing pat on rates now “calls into question why they've been tightening all

        along,” Mr. Hess said.

        “Their justification for their action ... does not seem to be consistent. Sometimes good numbers are good numbers, and sometimes good numbers are bad numbers.”
Comes down to inflation

               If the Fed stands pat on rates but moves to a neutral bias, that means an end to the latest battle in the war against inflation. Without fear of further rate hikes, the stock market would take off and spending would climb.

        That would potentially reaccelerate the economy. “The Fed does not want to give the investment community reason to bid equity prices sharply higher on the basis of sensing an end to the latest episode of rate hikes,” said John Lonski, chief economist at Moody's Investors Service in New York.

        The consistent numbers on inflation might mean inflation's not much of a threat, but “I would say there's no more than a one-third chance” of the Fed shifting to a neutral bias, Mr. Mayland said.

        Lynn Reaser, chief economist at Banc of America Capital Management, agreed: “I think they still truly believe the primary risk is a pickup in inflation,” more so that a risk of recession, she said. “Inflation is well behaved, and the economy is moving off a high trajectory to a more sustainable track.”

        The Fed is also expected to “stay on the sidelines” the rest of the year, Ms. Reaser said.
Not election issue

               Conventional wisdom is the Fed doesn't like to change interest rates too close to an election, especially a presidential election. The Fed's next meeting is Oct. 3, its last before the election.

        “The economy is not an issue in the election,” Mr. Lonski said.

        “The Fed's not going to hike interest rates unless the economy regains momentum,” and if that happens, “Al Gore's not going to complain,” he said. “All he's going to talk about is how the economy's flourishing, and why change horses?”

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