Fed expected to cut rates again — but by how much?

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With another Federal Reserve Board meeting right around the corner, it appears policymakers will keep the rate-cutting limbo line going. The big question is: “How low can they go?”

Fed Chairman Alan Greenspan and other members on the Fed’s rate-setting group, the Federal Open Market Committee, could cut rates by one-quarter of a percentage point, or 25 basis points. But they might opt for a larger 50-basis-point cut at their two-day meeting, which wraps up June 27. Experts aren’t sure.

While the latest news on unemployment, industrial production and corporate earnings has been grim, policymakers may want to moderate the pace of their cuts to keep from overshooting and providing too much economic stimulus.

Regardless of what happens, the key federal funds rate will fall below 4 percent for the first time in more than seven years. That means borrowers and savers likely will see the lowest rates in years on everything from home equity lines of credit to certificates of deposit this summer.

“It’s still a jump ball,” says Richard B. Hoey, chief economist at Pittsburgh-based Mellon Financial Corp. He thinks the latest economic news has been bad enough to warrant a 50-point cut.

“First of all, the labor market continues to deteriorate, and the Fed has to be concerned that a continuing rise in the unemployment rate could undermine consumer demand. The second element is that while the Fed doesn’t focus on managing the overseas economies, what has occurred is there has been clear evidence of economic weakness in Europe and Asia.

“The third element is that Greenspan’s comments about inflation (on June 20) imply an environment where it’s acceptable to ease 50 basis points. In other words, he basically said he didn’t see a lot of inflation risk, and that’s the kind of statement that doesn’t force a bigger ease but is permissive of a bigger ease.”

Previous Fed moves in 2001 haven’t sparked so much debate because the economic news released before them was almost universally bad. Higher unemployment, lower corporate profits, rising energy costs, falling stock prices: virtually everything was stacked against Fed members.

But the Fed has now cut rates in five 50-basis-point steps, two of which came between regularly scheduled meetings. While economic news hasn’t improved much, the incredibly aggressive rate-cutting regime has some experts optimistic that it will get better soon.

For one thing, rate cuts work with a six- to 12-month time lag, and the first cuts happened in January. For another, businesses are working down the inventories they built up last year in hopes of strong growth that didn’t materialize. If demand for their goods picks up, they’ll have to boost production (and hiring, since assembly lines need workers to run them).

Demand should be there too, experts say. Lower borrowing costs will boost corporate and consumer spending, while lower tax rates and rebates will pad the wallets of average Americans around the country.

“This growth slowdown is getting old and these things just run their course,” says Ken Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio. He is leaning ever-so-slightly toward expecting a 25-basis-point cut.

“If you use — and I don’t think we’re in a recession — but if you use a recession model, the average recession has lasted 10 months in the post-World War II period. The longest two lasted 16 months, and we are already 12 months into this process.

“Layer on top of that an aggressively easy monetary policy and layer on top of that something we haven’t seen in a long time, an easier fiscal policy. It’s been a long time since we’ve seen major tax cuts. This is a major tax cut and it’s front-loaded too,” he says. “Put that all together and that provides much better visibility on the economy’s prospects.”

Then again, experts have been predicting a rebound for some time now. Because businesses spent so heavily on technology equipment and other goods designed to boost their efficiency the past couple of years, they may take a longer-than-anticipated breather.

Without such capital spending to boost growth, any rebound will have to come from the consumer side of the economy. And some observers don’t think Americans are in a position to spend more because of job losses and high debt burdens.

As for the future course of Fed policy, it all depends on the numbers. If economic news releases start indicating that this year’s Fed cuts are working, the upcoming cut could be the last. If the news doesn’t improve, another 25 or 50 points worth of cuts could be forthcoming. After June, the Fed isn’t scheduled to meet until Aug. 21.

“My best guess right now is that (the June cut) is going to turn out to be the end. If not, there will be another 50, but I think that’s going to prove to be enough,” says Jim Coons, director of balance sheet management at Columbus, Ohio-based Huntington Bancshares Inc.

“There is something to what the market-based indicators are telling us, so I’m expecting the economy to bottom out this quarter.”

— Posted: June 22, 2001