Wall Street wants 50, Fed may give zip for now
By Agencies |
WASHINGTON: Some Wall Street analysts are claiming financial markets have taken such a turn for the worse that Federal Reserve officials should cut interest rates by a half-percentage point next week. That’s not going to happen, nor should it. A quarter-point cut is a closer call, though some officials don’t think it’s needed at this point.
At the September 18 meeting of the Federal Open Market Committee, Fed officials voted to cut their target for the overnight lending rate by 50 basis points, to 4.75%. Some wanted 50 rather than 25 basis points in order not to create a market expectation of a series of such reductions.
“It was good policy to get out ahead and stabilise the market,” said William Poole, president of the St. Louis Federal Reserve Bank in an October 19 interview. “If we did 25, then we would have had the market expectation of 25 at the next meeting,” he said. “So it was better to do 50 at once and have the market settle down.”
Nevertheless, options contracts on Tuesday indicated only about a fourth of investors expect the Fed to leave the target unchanged when it meets October 30-31. Not quite two-thirds anticipate a quarter-point cut and 11% are looking for a half-point. More bad news in the housing sector of the economy, large declines in profits at some of the largest banks in the country and a plunge in stock prices on October 19 probably created these expectations.
There’s no indication Fed officials share the dire outlook of gloomy analysts such as Andrew Brenner, co-head of structured products at MF Global. “If the Fed wants to keep the economy going and the Fed wants to keep housing from deteriorating further and they want to keep the banking system solid, they are going to have to ease by 50, as well as 50 in the discount rate,” Brenner said in an October 22 interview.
Actually, the well-capitalised US banking system is very solid even with large losses from recent market turmoil.
Bank of America also had a large addition to loan-loss reserves, a substantial drop in earnings and still reported a $3.7 billion net. JPMorgan Chase also booked potential losses while its earnings rose slightly to $3.4 billion. As for the bad news in housing, Poole said, “The numbers are about as expected. They were hardly a surprise. I regard them as a continuation of the housing distress.”
In other words, the 10% drop in housing starts last month, to a 1.19 million annual rate-a 14-year low-isn’t seen, at least by Poole, as a reason to reduce the lending target next week.
Similarly, he sees no reason for the Fed to respond to the slowdown in payroll employment growth evident in the September labour market report released October 5. Payrolls increased an average of 97,000 a month in the third quarter, down from 126,000 in the second quarter and 142,000 in the first.
A monthly gain of a little less than 100,000 is “perfectly in equilibrium” with expectations of labour force growth, he explained. “It was generally encouraging, not evidence that the labour market was sinking.”
Meanwhile, strains in the money markets continue to dissipate slowly.
Charles L Evans, Poole’s counterpart at the Chicago Fed, said of the markets in an October 22 speech, “There still is a way to go. Improvements are not uniform, and risks remain. However, markets are functioning better than they were two months ago.”
As for the economic outlook, Evans said that “our baseline forecast sees soft economic activity this fall; notably, it is likely that a further sharp decline in residential investment will weigh on the top-line growth numbers.”
“But we see growth recovering next year and moving up to average close to potential later in 2008, which we at the Chicago Fed currently see as being somewhat above 2 1/2%,” he said.
And recent economic news hasn’t caused him to modify that forecast.
“On balance, I would characterise the data we have received on the real economy since the last FOMC meeting as supporting our baseline forecast,” Evans said.
However, he did raise the question of whether policy makers might want to take out some “insurance” against a potentially costly possibility that even greater weakness in housing could undermine economic growth.
Given what Fed officials were thinking on September 18 and what has happened since, that is about the only argument that might cause the FOMC to decide to cut rates next week even by 25 basis points.
At the September 18 meeting of the Federal Open Market Committee, Fed officials voted to cut their target for the overnight lending rate by 50 basis points, to 4.75%. Some wanted 50 rather than 25 basis points in order not to create a market expectation of a series of such reductions.
“It was good policy to get out ahead and stabilise the market,” said William Poole, president of the St. Louis Federal Reserve Bank in an October 19 interview. “If we did 25, then we would have had the market expectation of 25 at the next meeting,” he said. “So it was better to do 50 at once and have the market settle down.”
Nevertheless, options contracts on Tuesday indicated only about a fourth of investors expect the Fed to leave the target unchanged when it meets October 30-31. Not quite two-thirds anticipate a quarter-point cut and 11% are looking for a half-point. More bad news in the housing sector of the economy, large declines in profits at some of the largest banks in the country and a plunge in stock prices on October 19 probably created these expectations.
There’s no indication Fed officials share the dire outlook of gloomy analysts such as Andrew Brenner, co-head of structured products at MF Global. “If the Fed wants to keep the economy going and the Fed wants to keep housing from deteriorating further and they want to keep the banking system solid, they are going to have to ease by 50, as well as 50 in the discount rate,” Brenner said in an October 22 interview.
Actually, the well-capitalised US banking system is very solid even with large losses from recent market turmoil.
ADVERTISEMENT
For instance, Citigroup reported on October 15 that in the third quarter it had booked about $6.5 billion to cover possible losses in fixed-income trading, underwriting and consumer lending, and it still earned $2.38 billion. Yes, earnings were much lower than in the same quarter a year earlier. In terms of the health of the banking system, though, the remarkable point was that Citigroup could absorb such potential losses and still be profitable.Bank of America also had a large addition to loan-loss reserves, a substantial drop in earnings and still reported a $3.7 billion net. JPMorgan Chase also booked potential losses while its earnings rose slightly to $3.4 billion. As for the bad news in housing, Poole said, “The numbers are about as expected. They were hardly a surprise. I regard them as a continuation of the housing distress.”
In other words, the 10% drop in housing starts last month, to a 1.19 million annual rate-a 14-year low-isn’t seen, at least by Poole, as a reason to reduce the lending target next week.
Similarly, he sees no reason for the Fed to respond to the slowdown in payroll employment growth evident in the September labour market report released October 5. Payrolls increased an average of 97,000 a month in the third quarter, down from 126,000 in the second quarter and 142,000 in the first.
ADVERTISEMENT
“That was a pretty solid report,” Poole said. “We have all been expecting it to be lower because the demographics have really been taking hold.”A monthly gain of a little less than 100,000 is “perfectly in equilibrium” with expectations of labour force growth, he explained. “It was generally encouraging, not evidence that the labour market was sinking.”
Meanwhile, strains in the money markets continue to dissipate slowly.
ADVERTISEMENT
Charles L Evans, Poole’s counterpart at the Chicago Fed, said of the markets in an October 22 speech, “There still is a way to go. Improvements are not uniform, and risks remain. However, markets are functioning better than they were two months ago.”
As for the economic outlook, Evans said that “our baseline forecast sees soft economic activity this fall; notably, it is likely that a further sharp decline in residential investment will weigh on the top-line growth numbers.”
“But we see growth recovering next year and moving up to average close to potential later in 2008, which we at the Chicago Fed currently see as being somewhat above 2 1/2%,” he said.
And recent economic news hasn’t caused him to modify that forecast.
“On balance, I would characterise the data we have received on the real economy since the last FOMC meeting as supporting our baseline forecast,” Evans said.
However, he did raise the question of whether policy makers might want to take out some “insurance” against a potentially costly possibility that even greater weakness in housing could undermine economic growth.
Given what Fed officials were thinking on September 18 and what has happened since, that is about the only argument that might cause the FOMC to decide to cut rates next week even by 25 basis points.
Download
The Economic Times Business News App for the Latest News in Business, Sensex, Stock Market Updates & More.
The Economic Times Business News App for the Latest News in Business, Sensex, Stock Market Updates & More.
Download
The Economic Times News App for Quarterly Results, Latest News in ITR, Business, Share Market, Live Sensex News & More.
The Economic Times News App for Quarterly Results, Latest News in ITR, Business, Share Market, Live Sensex News & More.
ADVERTISEMENT
