A committee of the Federal Reserve is expected to cut short-term interest rates on Tuesday, adding tinder to an economy that seems on the verge of re-igniting.
Economists and investors expect the Fed’s open market committee to cut the overnight lending rate by one-quarter of a percentage point, from 2 percent to 1.75 percent. It would be the 11th cut of the year. On Jan. 1, the overnight lending rate (also called the federal funds rate) was 6.5 percent.
According to the National Bureau of Economic Research, economic activity peaked in March and then began sputtering out, ending a decade of economic expansion. The private, nonprofit research organization says economic activity has been declining since the March peak and that the downturn officially became a recession this fall.
The Fed cut rates through the year to head off or cushion a recession. Although the Fed didn’t avoid a recession, it probably softened the blow. In fact, the NBER says the Sept. 11 attacks were probably the tipping point that turned what would have been a brief downturn into a recession.
Some recent news points to a recovery. The economy’s service sector seems to be growing, fewer people are being laid off and factory orders are up. Those are the kinds of sparks that, if carefully tended, could flare into a smooth-burning economy. In response, stock prices have risen and so have long-term interest rates.
On the other hand, the manufacturing sector is still in a slump and unemployment is rising; even though there has been a decline in layoffs, jobless people are having trouble finding work. And the private, nonprofit American Bankruptcy Institute says a record 1,437,354 bankruptcies were filed in the 12 months ending Sept. 30. In Tennessee, one in 37 households filed for bankruptcy during that period.
“Hangover consumer debt from the free-spending ’90s and a weakened economy today mean more families will face the need to file for (bankruptcy) protection well into next year,” says Samuel Gerdano, executive director of the institute.
With mixed news like that, most observers expect the Fed to err on the side of action and to cut rates.
Like most economists, Michael Cosgrove believes the Fed will cut short-term rates by one-quarter of a point. He thinks policymakers might have just as much concern about what’s happening abroad as what’s happening with the economy here.
Cosgrove, principal of The Econoclast, an economic research firm in Dallas, says he expects the rate cut “because of the dire shape that the global economy is in — Europe, some South American countries and some of the Far Eastern countries.”
He says the Fed is keeping an especially close eye on Argentina, whose government is taking desperate measures to repay some debt. Argentina has limited cash withdrawals, banned overseas money transfers and confiscated billions of dollars’ worth of pension funds.
“The Federal Reserve doesn’t want the difficulties in Argentina to spread throughout South America and the Far East,” Cosgrove says, and that’s an argument to lower the short-term interest rate on Tuesday.
Sluggish road to recovery
Fed policymakers also are concerned about the economy at home. Michael Moskow, one of the Fed members who will vote on whether to cut interest rates, said last week: “We expect the recovery to improve next year, although the timing is uncertain. Looking ahead, we are likely facing a period of quite sluggish economic activity.”
Observers took that as a hint that the Fed is still inclined to cut the federal funds rate. Other Fed members have made similar statements in the last two weeks.
Futures traders expect this to be the last rate cut in the Fed’s yearlong easing campaign. In the Chicago Board of Trade’s interest-rate futures market, traders believe there’s an 80 percent chance that the Fed will cut short-term rates by a quarter of a percentage point on Tuesday.
But traders aren’t so sure that the Fed will cut rates at the end of January. A couple of weeks ago, the consensus was that the Fed would cut rates in January, too. Now many observers expect to see much stronger signs of recovery by the time the Fed next meets Jan. 29 and 30, so the Fed probably will leave rates alone then.