Fed expected to downshift into neutral bias

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Remember that scene in the movie
Titanic where the lookout spotted trouble and yelled “Iceberg, right ahead”? Well, some say that’s where the U.S. economy is now.

Unemployment has risen because of slowing job growth. Consumer confidence has fallen due to cascading stock prices. Holiday sales have been sucking wind because of lax spending. Add it all up and the American economic juggernaut once considered unsinkable is getting ready to meet a watery disaster, according to several economists. That’s why market watchers expect Federal Reserve Chairman Alan Greenspan will signal that he’s ready to cut rates on Dec. 19, then follow up with actual cuts early next year.

“The economy is definitely slowing down. Retail sales that came out were weak. Employment growth is weak and there’s real concern the economy is going to slow much more than anyone wants,” says Susan Hickok, chief economist with Prudential Insurance Company of America in Newark, N.J. “The risk of a greater-than-desirable slowdown is very real.”

A year ago, few would have thought we’d be facing this kind of predicament. The stock market was roaring at the time and rate hikes were all the rage. But after steadily boosting the federal funds rate to 6.5 percent from 4.75 percent in May 1999, Fed officials have succeeded in cooling things down. Now, they’re poised to change course in order to prevent growth from slowing too much.

Experts say they have their work cut out for them.

Signs of slowdown everywhere
After remaining steady at 3.9 percent during September and October, for instance, the unemployment rate ticked up to 4 percent in November.

The Nasdaq stock market, whose late-1999 and early-2000 rally boosted consumer spending for a while, has now completely retraced its steps.

Manufacturing activity, as measured by the National Association of Purchasing Management, has contracted for four straight months. The group’s Purchasing Managers’ Index touched 47.7 percent in November — its lowest reading since the end of 1998, when the Asian economic crisis stifled demand for U.S. goods.

“You had that enormous surge in the stock market that went from November of last year through February and that gave people who owned those shares a lot of wealth,” Hickok says. “Since then, the NASDAQ has given back all those gains.

“We’re seeing layoffs because of the slowing economy and these layoffs are going to accumulate,” she adds. “Our forecast is that the unemployment rate will continue to inch up.”

That should cause members of the Fed’s Federal Open Market Committee, who set interest rate policy, to temper the tone of their post-meeting statement in mid-December. They will probably say the risks of inflation accelerating too quickly or the economy slowing too much are about equal. For more than a year, they’ve been using stronger language warning that inflation is the primary threat.

Hickok doesn’t expect an outright rate cut before the end of the year. But she says the Fed will lower rates by three-quarters of a percentage point, or 75 basis points, in 25-point increments at their first three meetings of 2001. The first is a two-day gathering Jan. 30 and 31, while the next two one-day meetings will take place March 20 and May 15.

Not all predicting rate relief
Consumers should keep in mind, however, that not everyone is so positive about the rate outlook. Some experts say economic growth will continue, albeit at a slower pace, and unemployment will remain low enough that rising labor costs will continue to pose an inflationary threat. That could keep the Fed from cutting rates and may even prompt it to raise them later next year.

“We’ve really only had a one-quarter slowdown and we expect that to pick back up,” says Peter G. Glassman, domestic economist for Chicago-based Bank One Corp. He sees the Fed raising rates twice — by 25 basis points each time — during the second half of 2001.

“You’re going to get strong growth and you’ve still got to worry about inflation.”

— Posted: Dec. 15, 2000