In 30 words or less, here’s the economic backdrop ahead of today’s Federal Reserve Board meeting:
Layoffs are increasing. Consumer optimism is falling. Home sales are weakening. Profit warnings are picking up. Stock prices are heading down. Oil prices are leveling off. Inflation is stagnating.
So will consumers catch a rate break by Thanksgiving? Probably not, because officials want to see if this slowdown’s for real. But they may get one by Easter. And there’s an outside chance Fed officials will announce they’re downshifting from an “inflation-remains-a-significant-threat” stance to a neutral one.
“The economy has decelerated — not severely, but there’s enough out there to suggest that the Fed would be pleased,” says David Littmann, chief economist with Comerica Inc. in Detroit. While he doesn’t see an official bias change quite yet, “that may come on the 19th of December meeting prior to Christmas to prepare the way for perhaps rate cuts early next year.”
Certainly, much more than the leaves have changed since May. In the spring, pessimism about interest rates ran rampant and some experts figured 9 percent 30-year mortgages were right around the corner. Now, even 8 percent ones seem a bit anachronistic as stock market weakness, faltering consumer optimism, and cooling home and auto sales have sent rates sliding.
Sales of existing homes, for instance, came in at an annual pace of 5.14 million in September. That’s only slightly below last September’s 5.15 million pace, but well below this June’s 5.31 million, according to the National Association of Realtors. The Conference Board’s Consumer Confidence Index dropped to 135.2 in October — its lowest level in a year. And electronics, clothing and discount merchandise retailers such as Best Buy, Gap, Kmart and Ames have all warned in recent weeks that a drop-off in consumer spending would hurt sales and earnings.
“The economy has shown evidence that it’s starting to slow,” says Philip Jefferson, associate professor of economics at Swarthmore College in Swarthmore, Pa. “The interest rate increases over the past year have started to take hold.”
At the same time, things haven’t yet cooled off enough to prompt actual rate cuts, according to most economists. Unemployment held at 3.9 percent in October and the percentage of workers who voluntarily left jobs rather than got fired remained high, according to data from the Bureau of Labor Statistics. That suggests employees are having little trouble finding work and may still be able to play potential employers against each other in order to extract higher salaries and benefits. Fed officials worry companies will boost prices for their goods and services to cover those rising labor costs, spurring inflation.
“They want to make sure they have confirmation that things are indeed continuing to slow,” says Littmann. “They’d like some confirmation in the labor markets.”
But even if policymakers don’t cut rates before the end of the year, they may signal a shift in their stance toward them. Consider that after every meeting, Fed officials issue a statement that contains a few comments about the economy and one sentence with pre-set language indicating whether the risk of inflation appears to be increasing, holding steady or waning.
For some time, they have included the “risky” sentence in their communiqu?s. But Jefferson thinks they may opt for the “neutral” one. Littmann sees the same thing happening, though not until December, when officials gather for the last time in 2000. After that, it could only be a matter of time before policymakers start dropping rates. Jefferson doesn’t think it will happen anytime soon, but Littmann believes there may be two one-quarter of one percentage point, or 25 basis point, rate cuts in store for borrowers sometime during the first half of 2001.
Given this outlook, savers may want to lock in certificate of deposit rates while they’re still high. Home equity borrowers, on the other hand, might want to opt for variable-rate lines of credit rather than fixed-rate loans so they can benefit if interest rates drop. Keep in mind that mortgage rates have already started falling in anticipation of future cuts. If economic developments suggest a deepening slowdown, that trend could continue.
“We’re coming down off a peak, so with the softening of the economy, I don’t think the Fed is going to be moving in the up direction anytime soon,” Jefferson says. “If I were in a position to wait one or two quarters before plunking down that down payment on a home, I would wait. I think there will be some softening there.”
— Posted: Nov. 15, 2000