Fed expected to hold rates steady

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Members of the Federal Reserve’s rate-setting committee probably don’t yet know what they’ll decide when they meet this afternoon.

That makes it kind of tough for outsiders to predict what the Federal Open Market Committee will decide. When pressed, experts say they believe the Fed will hold short-term rates steady.

The Fed could leave the federal funds rate alone at 1.25 percent, or cut it by one-quarter or one-half a percentage point. No one believes the committee will raise the rate.

The federal funds rate also is known as the overnight rate because it’s what member banks charge one another for overnight loans. Other interest rates are based on the overnight rate. The most important of these is the prime rate, which is 3 percentage points higher than the overnight rate. Many consumer rates — for credit cards, auto loans and home equity loans, for example — are based on the prime rate.

Fixed rates on 15- and 30-year mortgages do not move in lockstep with the prime rate and instead tend to move in the same direction as yields on 10-year Treasury notes.

War in Iraq seems inevitable, and the Fed probably will wait until the conflict is resolved before messing with interest rates, economists believe. If war weren’t imminent, the Fed still would confront a foggy economic landscape. But right now, economists believe, the only fog the Fed cares about is the fog of war.

“This is the first time in my recollection that the economy is so dependent upon the political and international situation,” says Anthony Liuzzo, professor of business and economics at Wilkes University in Wilkes-Barre, Pa. “The Middle East situation and to a lesser extent the North Korea situation have really been hurting the economy. Once this situation is resolved, I would fully expect that we would bounce back nicely.”

There’s a phrase that Liuzzo uses — “once this situation is resolved” — that just about every economic expert deploys in some form. Economists don’t expect the Fed to lower or raise short-term rates until the Iraq situation is resolved. Trouble is, no one knows what “resolved” means in this case. The beginning of a ground war? The end of a ground war? The ouster of Saddam Hussein?

People say they’ll know there’s a resolution to the conflict when they see it.

Many experts, including Fed Chairman Alan Greenspan, agree with Liuzzo that the economy will rebound when the situation in Iraq is resolved. They blame the poor economic news of late — rising unemployment, declining retail sales, falling consumer confidence — on worries about Iraq. Specifically, experts believe that businesses are holding off hiring and investment decisions until the Iraq situation clears up.

Liuzzo says he believes the Fed will hold steady Tuesday, but will act quickly to cut rates if the economy doesn’t bounce back quickly after the Iraq conflict is settled.

Richard DeKaser, senior economist for National City Corp., says he expects the Fed’s rate-setting committee to spend a lot of time discussing Iraq and North Korea, and what could happen between Tuesday’s meeting and the next scheduled meeting, on May 6. He doubts the panel will cut short-term rates.

DeKaser adds that he expects the committee to discuss bank deposit balances. It looks as though business’s bank deposits have been rising swiftly over the past six to eight months. That implies that businesses have money to spend, but they’re not spending because they’re worried about Iraq. If that’s the case, DeKaser says, there won’t be any need to cut interest rates to encourage businesses to spend. They’ll start hiring people and buying equipment after they see Saddam Hussein’s corpse hanging from a lamppost, literally or metaphorically.

Not everyone is confident of an easy, inexpensive U.S. victory. Robin Dubin, an associate professor of economics at the Weatherhead School of Management at Case Western Reserve University in Cleveland (WSMaCWRUiC for short) worries about the bad things that can happen.

“It could be a much more protracted war” than expected, she says. Even if it’s quick, governments of other countries could express their displeasure in myriad ways.

“I don’t personally think it’s going to be a short and happy event,” Dubin says. “I think it’s going to be an expensive war, and I don’t think anybody’s going to help us pick up the bill this time because they think it’s a bad idea.”

Hefty bills and widespread international condemnation don’t constitute a recipe for robust economic growth. If the war and its aftermath go awry, the Fed will stand ready to cut short-term interest rates for the 13th straight time in the past 26 months.

The Chicago Board of Trade says futures traders had priced in a 42 percent chance of a quarter-point rate cut in Wednesday’s trading. That likelihood had dropped to 32 percent on Thursday morning, and to 26 percent Thursday afternoon.