Fed's rate increases to brake economy are not finished, but could be soon.

WASHINGTON - Federal Reserve officials are not done yet with their job of raising short-term interest rates to cool the economy, but they may not have too far to go, either, according to analysts.

Many economists believe that Fed policymkers will tighten credit once again at the next meeting of the Federal Open Market Committee on July 5-6, lifting the federal funds rate to 4.5% from 4.25%.

What happens after that is more open to debate. Some analysts believe Fed officials will probably stay put for the rest of the year, while others see one or two more adjustments that bring the funds rate to 5%.

In either case, there seems to be a general belief among market participants that the worst of the bond market's sell-off is over, and some say long rates may edge down before the end of the year.

"I think the bond market has become more of a fair fight," said Robert DiClemente, director of bond market research for Salomon Brothers Inc. "The factors that precipitated the Fed's tightening are still largely in place, but tightening is acting relatively quickly without threatening the economy, and we'll see some slowing in growth some time next year."

The latest economic forecast of the National Association of Business Economists, released yesterday, calls for real gross domestic product to swell by 3.6% this year. That would be well above the growth rate of about 2.5% that the economy can sustain without rekindling inflation pressures, said William Dunkelberg, president of the group and chief economist for the National Federation of Independent Business.

But the group's panel of forecasters predicted that GDP growth will slow to 2.8% in 1995 as consumers rein in their spending habits and as business and residential investment - two interest-rate sensitive sectors that have been going gangbusters - grow more modestly.

The business economists, like most analysis, failed to predict this year's sharp upturn in interest rates. Still, their latest forecast predicts that in 1995 the yield on 30-year bonds will be 7.3% - down from yesterday's yield of 7.4% - while the rate on three-month Treasury bills will rise to 4.8%.

"Once the market is convinced that the Fed is truly going to fight inflation, will do anything it has to do to keep inflation down, and gets used to the new higher rates at the short end, we think those long rates will end up being in the range of 7% to 7.5%," said Dunkelberg.

The case for at least one more move by Fed policymakers to tighten credit is fairly clear-cut because the economy is continuing to operate with a large head of steam, analysts said. While the Commerce Department estimates that GDP grew a moderate 2.6% in the first three months of this year, that represents a temporary setback from an unusual drop in government spending, the California earthquake, and bad weather.

Estimates of second-quarter GDP growth in a range of 3.5% to 4% are common, said Sam Kahan, chief economist for Fuji Securities Inc.

Federal reserve policymakers left themselves some wiggle room to nudge up short-term rates again in the language they used in their press release last week when they raised the federal funds rate to 4.25% from 3.75%. They said the rate increases, "substantially remove the degree of monetary accommodation which prevailed throughout 1993."

The use of the word "substantially" led many analysts to suspect Fed Chairman Alan Greenspan and his colleagues still have one more credit tightening in mind in response to another batch of strong economic reports, which seem to be coming.

Any further rate-tightening could set up Greenspan for more criticism from Congress, where some members have blasted the Fed for putting the brakes on the economy when the inflation numbers remain so reassuring. The Senate Banking Committee has called in Greenspan this Friday to defend the Fed's rate increases.

Even some optimists on inflation see signs that price pressures are creeping higher as the economy continues to chew up spare capacity. The business economists, in their survey released yesterday, predicted consumer prices will rise only 2.8% this year. But they forecast that prices will rise 3.4% in 1995 as labor markets tighten and workers find a little leverage in their ability to get higher pay.

The broader debate among economists is what course the Fed will take in the second half of the year, with some arguing there may not be any more increases in short-term rates and others saying there will be.

The question has split the large brokerage firms on Wall Street. Merrill Lynch & Co. and Goldman Sachs & Co. said they believe the Fed's job is largely accomplished for the year, while Salomon Brothers Inc. argues that the federal funds rate is still low by historical standards in an expanding economy. A funds rate of 5% is likely to be in place by this winter, analysts at Salomon said.

Mickey Levy, chief financial economist for CRT Government Securities Inc., said he does not expect Fed officials will lift the federal funds rate much higher than 4.5%. Levy reads the slowdown in bank reserves and M1, the narrow measure of the money supply, since last November as evidence that the Fed is already tapping lightly on the brakes.

While a strong economy and inflation fears could temporarily push the yield on the long bond to 7.75%, U.S. output will probably slow by the fall, Levy said. "Rates are not going to explode on the upside," he said. "The economy is growing above potential, but the Fed has begun to snug."

Analysts at DRI/McGraw-Hill Inc., the forecasting outfit in Lexington, Mass., estimate that growth next year will slow to a tepid 2% as business and housing investment fall off sharply. "Higher interest rates really do slow the economy, especially higher bond yields," said David Wyss, senior vice president.

While analysts at DRI anticipate another move or two by the Fed to raise short-term rates, "we think that by the end of the year, there'll be some weaker numbers coming in that'll deter the Fed from tightening further," said Cynthia Latta, senior financial economist.

Not everyone is optimistic that the Fed is close to ending its policy of raising rates. "You're talking about the business cycle at work, and in this phase in the business cycle you can only expect short-term rates to push higher in the next few years," said Anthony Karydakis, senior financial economist for First National Bank of Chicago.

"By the time this cycle runs its course, fed funds are going to be at much higher levels. If I had to guess under the gun, I would say somewhere around 6% or 7%, at least," Karydakis said.

However, even Karydakis said he sees the chance that the combination of a tough-acting Fed, favorable inflation reports, and evidence of a slowing economy later this year will bring a temporary lift to the bond market. He does not rule out a drop in the long bond to 6.5%, before it begins climbing once again. Business Economists See Slowdown in Growth Forecast: '94 '95 Real GDP 3.6% 2.8%Personal spending 3.6% 2.7%Unemployment rate(*) 6.4% 6.1%Consumer Price Index 2.8% 3.4%Treasury bills (3 months) 4.1% 4.8%Treasury bonds (30 year) 7.2% 7.3% (*) Civilian.Source: National Associationof Business Economists

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