WASHINGTON -- The bond market is primed for the Federal Reserve to nudge short-term interest rates down another notch to help the weak U.S. economy, but whether Fed officials prove accommodating is not a sure bet.
"The traders -- the guys that are putting their money to work -- are betting the Fed is going to continue its easing mode," said Mort Kelly, manager for Brown Brothers Harriman & Co. "What the Fed is going to do is the question everyone faces."
Members of the Federal Open Market Committee, which sets monetary policy, are scheduled to meet tomorrow. The betting in the market is that Alan Greenspan, chairman of the Federal Reserve Board, and his colleagues are inclined to cut the discount rate to 5.0% from 5.5% and knock down the federal funds rate to 5.25% from 5.5%.
Another cut in short-term rates, following the Aug. 6 move by the Fed that lowered the federal funds rate from 5.75%, would lead commercial banks to cut the prime rate from 8.5% to 8%, analysts say. Banks have been reluctant to pass on the lower cost of funds by easing loan rates as they sought to build up balance sheets and cut losses.
This week's meeting of the FOMC follows repeated calls from the Bush administration for lower interest rates to sustain the economy. Recently the President and his aides have begun preparing for next year's elections, and analysts say a healthy economy is critical to Republican ambitions.
Members of Congress have also indicated their restlessness with the Fed. Before leaving for the August recess, Democratic leaders of the congressional Joint Economic Committee introduced legislation to remove the Federal Reserve District Bank presidents from the FOMC on the grounds that they are not directly accountable to the public.
Apart from whatever political pressures may be facing Fed policy-makers, some analysts say there are sufficiently compelling economic and financial reasons for another cut in rates. With inflation receding and the bond market in a positive mood roward another Fed easing, policymakers are in a good position to try to nurse the economy along a little more, the argument goes.
"We're having growth, and the recession is over," said Joseph Liro, senior vice president for S.G. Warburg & Co. "It's just an agonizingly slow expansion. Normally, you move out of a recession pretty handily," he said.
Last week's economic reports from the government painted a more positive tone that contrasted with the July unemployment report that was issued Aug. 2 and showed a decrease in nonfarm payroll jobs. Retail sales, industrial production, and housing starts all posted continuing gains, and the Commerce Department reported that the merchandise trade deficit in June hit the lowest level in eight years.
Despite the renewed evidence of economic recovery, analysts say there are still reasons for Fed officials to worry whether a sustainable expansion is under way. For one thing, consumers still seem edgy and uncommitted in their buying plans. A preliminary report from the University of Michigan for early August showed consumers confidence edged down.
Lyle Gramely, chief economist for the Mortgage. Bankers Association, said he is confident that the economy is not stalling out. Low business inventories will lead companies to step up production to keep their shelves from being swept bare, he said. Still he added, "the worry is that once this inventory rebound gets behind us, there won't be any momentum to carry us forward because credit restraint will choke us all of."
Indeed, Fed officials have cited concerns about the credit crunch and slow money supply growth as prime reasons for their earlier moves to lower rates. Growth in the M2 measure of money, which includes certificates of deposit and money market funds, fell by $10.6 billion in July and has barely grown over 2.5% since the beginning of the year.
Analysts are divided on what the slowdown in the money supply means for Fed policymakers. Some argue that it reflects the flight by investors from CDs and moneymarket accounts into higher-yielding stock and bond funds and therefore is simply a shift of savings. The M2 measure of money excludes stock and bond funds. "It's not a big problem," said David Berson, senior economist for the Federal National Mortgage Association.
Other analysts said the slow growth in money reflects the banks' unwillingness to lend and requires action by the Fed to make sure the economy will be growing at a healthy pace next year, given the lag it takes for changes in rates to alter behavior by businesses and individuals. "There are valid concerns about the pace of economic expansion through the middle of 1992, given what we're seeing now in the lack of growth in the money supply," said Mr. Liro.
"There is a flood or deposits out of the banking system into the financial markets," said Gail Fosler, chief economist for the Conference Board. "The Fed has a very difficult time counteracting this, and the only way they have of doing so is to try and get confidence up and get banks to lend."
But not all analysts say they are confident Fed policymakers will opt for lower rates. It is normal to get conflicting statistics when the economy is recovering, said Mr. Berson, and another easing in short-term rates would slow growth in the money supply even more because it would chase more investors out of short-term savings accounts. There is also little evidence from small businesses that they are having trouble getting credit, he said.
Michael Moran, chief economist for Daiwa Securities America, said he expects Fed policymakers to stand pat through September. "The numbers we received this last week provide good evidence, the recovery is proceeding," said Mr. Moran.
