Fed expected to add another rate cut, but how much?

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The Federal Reserve Board will almost certainly serve up more economic stimuli on Jan. 31. But whether it’s another oversized heaping of interest rate pudding or something less remains to be seen.

Officials could cut rates by one-quarter of a percentage point, or 25 basis points, rather than the 50 basis points they dollaped out Jan. 3. Or, they could opt for the larger cut. Either way, rates on products such as credit cards, home equity lines of credit and certificates of deposit will head lower.

But they may not fall as much in the months ahead, as people once expected, thanks to a stock market rebound and increasing support for federal tax cuts — including a ringing endorsement from Fed Chairman Alan Greenspan on Jan. 25.

Tamed expectations
“For a while the market had baked in another 50 basis point cut, but some of the trail-off has been that people think it might only be a quarter,” says John Hoie, secondary market manager with Omaha, Neb.-based Commercial Federal Corp.’s mortgage company.

“They’re going to wait and see if the tax cuts do go through and the fact that Greenspan’s supporting that almost locks in some kind of tax cut,” he adds. The Fed “will probably go a little cautiously because of that. They don’t want a recession, but they also don’t want a speculative bubble.”

From last May through the end of 2000, the federal funds rate remained at 6.5 percent, and the discount rate stayed at 6 percent. Those two rates, which the Fed controls directly, guide market rates that banks charge on consumer loans and pay on savings deposits. But, in a rare inter-meeting move earlier this month, officials slashed the funds rate to 6 percent and the discount rate to 5.75 percent. Another 25 basis point discount rate reduction followed soon after.

The Fed indicated its moves were designed to bolster consumer confidence and stop a decline in sales and production of goods. Many speculated it wasn’t enough and that another 50 basis point cut would be announced on Jan. 31, the second day of a regularly scheduled two-day policy meeting.

Recession? What recession?

Since then, however, stock prices have risen, the corporate bond market has loosened up and the potential for President Bush’s promised tax cuts to become reality has increased. All of those factors could provide individuals and businesses with enough additional money to spend so that economic activity rebounds and aggressive Fed cuts won’t be necessary.

“They’re going to watch it carefully now and move in small increments,” Hoie says.

At the same time, further Fed cuts are all but guaranteed, and that means borrowing should get cheaper for consumers over the course of 2001. The Fed next meets on March 20, May 15, June 26 and 27 and Aug. 21. Over the course of those gatherings, the Fed should cut the funds rate all the way to 5.25 percent, according to the Economic Advisory Committee of the American Bankers Association.

“The shallow growth in the first half of this year may feel like a recession compared with the record expansion rates of recent years,” David Littmann, chairman of the ABA’s economic committee, said when releasing the group’s forecast on Jan. 24. But “the Federal Reserve’s recent rate cut was a good start. Two or three more cuts by midyear will help stabilize and then boost the pace of economic activity.”

— Posted: Jan. 27, 2001