Fed rate cut likely last of year; oil-fu­eled in­fla­tion feared

The Washington Times Weekly - - National - By Pa­trice Hill

The Fed­eral Re­serve, con­fronted with record-high oil prices near­ing $100 a bar­rel and un­ex­pect­edly strong eco­nomic growth of 3.9 per­cent in the sum­mer quar­ter, on Oct. 31 low­ered in­ter­est rates but in­di­cated it would be the last eas­ing this year be­cause of the ris­ing risk of oil­fed in­fla­tion.

The Fed’s quar­ter-point cut in its lend­ing rates for banks — which banks are ex­pected to quickly pass through to con­sumers — came as re­ports showed the econ­omy re­mained ro­bust and re­silient, de­spite an in­ten­si­fi­ca­tion of the hous­ing re­ces­sion caused by a mort­gage cri­sis in July and Au­gust.

The Com­merce De­part­ment said con­sumers and busi­nesses con­tin­ued to spend freely and were largely undeterred by the hous­ing tur­moil, con­tribut­ing to a nearly 4 per­cent growth rate.

In­come growth re­mained strong, and in­fla­tion also was re­mark­ably tame dur­ing the quar­ter, run­ning at a 1.6 per­cent rate, thanks in part to a drop in oil and gaso­line prices. But that trend has since re­versed course. On Oct. 31, pre­mium crude prices surged to a record of $94.53 in New York trad­ing on signs that stock­piles of fuel are dwin­dling only weeks ahead of the win­ter heat­ing sea­son.

The sharp gains in oil and other com­mod­ity prices pro­voked con­ster­na­tion at the Fed — and ap­par­ently di­vided the Fed’s rate-set­ting com­mit­tee — not only be­cause of their po­ten­tial to reignite in­fla­tion af­ter hard-fought im­prove­ments this year, but be­cause the Fed’s move to cut in­ter­est rates in the last two months was partly blamed for cre­at­ing the price spi­ral.

The rate cuts prompted a sharp weak­en­ing of the dol­lar, caus­ing a rise in oil, gold and other com­modi­ties that are priced in dol­lars. Wor­ries about in­fla­tion ap­par­ently were strong enough at the Fed’s two-day meet­ing that Thomas Hoenig, pres- ident of the Fed’s Kansas City Re­serve Bank, voted against the rate cut in a rare dis­sent at the con­sen­sus-seek­ing cen­tral bank. An­a­lysts said the in­fla­tion con­cerns his vote re­flected prob­a­bly forced the Fed to sig­nal it does not ex­pect to cut rates again.

“We think we are done eas­ing” is the clear mes­sage in the Fed’s state­ment, said Stephen Stan­ley, econ­o­mist at RBS Green­wich Cap­i­tal, not­ing that the Fed’s as­sess­ment that in­fla­tion risks are now equal to re­ces­sion risks “had all the sub­tlety of a sledge­ham­mer.”

The Fed ac­knowl­edged that the econ­omy is likely to per­form more poorly in com­ing quar­ters as it con­tin­ues to be pulled down by the hous­ing de­ba­cle and con­sumers and busi­nesses slowly re­act to the credit crunch and drop in house prices. But it said its cu­mu­la­tive rate cuts, to­tal­ing three-quar­ters of a per­cent­age point, “should help fore­stall some of the ad­verse ef­fects on the broader econ­omy.”

“We are sur­prised at the de­gree of hawk­ish­ness” barely a month af­ter the Fed re­versed course and ini­ti­ated a dra­matic res­cue of the econ­omy, Mr. Stan­ley said. One rea­son the Fed is try­ing to be un­usu­ally clear about its in­ten­tions, he said, is to “end the cat-and-mouse game where the mar­ket forces” it to cut rates by pric­ing in an­tic­i­pated Fed ac­tions, he said.

Still, the Fed has “plenty of flex­i­bil­ity if things turn sour on ei­ther the eco­nomic or the fi­nan­cial front,” he said. Stocks ral­lied on the rate cut, but bonds fell and the dol­lar con­tin­ued its slide.

Roger M. Kubarych, econ­o­mist at Unicredit Mar­kets, said it is not clear what the Fed will do next, since wor­ries re­main about both in­fla­tion and re­ces­sion. Given the stel­lar per­for­mance of the econ­omy de­spite the deep hous­ing slump, how­ever, he said the Fed will not cut rates again un­less it sees clear weak­ness in other sec­tors.

“It will take ei­ther a siz­able in­crease in the un­em­ploy­ment rate or a big drop in con­sumer spend­ing to force an­other eas­ing move,” he said. Con­sumer con­fi­dence slumped this month, but job gains ap­peared to re­main solid as ADP, the largest pay­roll pro­ces­sor, re­ported a large 106,000 in­crease in em­ploy­ment.

Richard Ya­marone, an econ­o­mist at Argus Re­search Corp., said the Fed fo­cused on the 20 per­cent drop in hous­ing in­vest­ment re­ported by Com­merce, and sur­mised that re­newed hous­ing woes will sig­nif­i­cantly crimp con­sumers, who have tapped into their home ap­pre­ci­a­tion in re­cent years to fi­nance spend­ing on an ar­ray of things from cars to col­lege ed­u­ca­tions.

But wor­ries about the con­sumer are over­done, he said. “The con­sumer has man­aged to ex­hibit tremen­dous re­siliency to so many in­flu­ences” with­out ca­pit­u­lat­ing, in­clud­ing re­ces­sion, war and dis­as­ter, he said. “Hous­ing prices have in­creased about 111 per­cent over the last decade, and now that they are off about 4 per­cent, ev­ery­one be­lieves con­sumers will toss in the towel.”

Mr. Ya­marone said the Fed is right to re­fo­cus its ef­forts on in­fla­tion. Not only is oil get­ting to threat­en­ing lev­els, food prices are “at el­e­vated and ir­ri­tat­ing lev­els,” and an­nounce­ments of price in­creases in ev­ery­thing from ham­burg­ers to tooth­paste have be­come com­mon­place.

“We do not ex­pect fur­ther eas­ing by the Fed, since the econ­omy is in no ap­par­ent need of stim­u­lus,” he said. “The Fed slash­ing rates in this en­vi­ron­ment is kind of like watch­ing your neigh­bor start up a bar­be­cue with a gal­lon of gaso­line and a Zippo.”

Bloomberg News

Traders at the Chicago Board of Trade fran­ti­cally sig­naled or­ders in the 10-year op­tions pit Oct. 31 af­ter the Fed­eral Re­serve sliced its bench­mark in­ter­est rate by a quar­ter point, in what is likely to be the fi­nal re­duc­tion it will of­fer.

Newspapers in English

Newspapers from USA

© PressReader. All rights reserved.