The Federal Reserve Board is widely expected to push up interest rates again this week, but signs are growing that it may have achieved its goal of cooling down the economy.
If so, the much-awaited peak in rates may finally be in sight. And that could revive bank stocks, which have languished as the central bank pressed its campaign of tightening credit to gag inflation.
"The markets have been expecting too much economic strength this year and much too much tightening by the Fed," said Mickey D. Levy, chief economist at NationsBanc Capital Markets Inc.
"Starting with retail sales, the economic data have turned mixed," he said. Friday's report of fourth quarter growth in gross domestic product was the latest indicator.
While GDP rose at a 4.5% rate in the year's final quarter, according to the Commerce Department, Mr. Levy and other economists noted that business activity tapered off as the year concluded.
"Consumption was obviously strong during September and October and tailed off in November and December," Mr. Levy said. "The quarter began on a very strong note and ended on a weaker one.
"It was also the third quarter in a row of very high inventory building," he noted. That can be a signal of softening in economic momentum. Mr. Levy expects a slowdown to 3% GDP growth in the first quarter.
He thinks Fed leaders will tighten again this week, but if business data continues mixed "they could very well put themselves on hold after this."
The Fed's policymaking Open Market Committee meets tomorrow in Washington. Half-point hikes in the federal funds rate, the rate for overnight loans of bank reserves, and the discount rate for Fed loans to member banks are anticipated.
"It is possible that federal funds rate could peak after the next move," Mr. Levy said. "Maybe there will be one more (increase), but we certainly won't get the kind of tightening that was expected a month ago."
Another economist said the Fed may be approaching a rate level that would amount to overtightening of credit, which could bring on a recession.
"We have obviously hit a point where additional increases in interest rates, combined with restraint from previous tightenings already in the pipeline, could have more impact on the economy than the Fed desires." said Sung Won Sohn, chief economist at Norwest Corp.
"There is some more cold water yet to come out of the pipe (from Fed actions last year)," he said. "My thinking is that this could be enough to slow the economy down for a soft landing."
"If we see additional tightenings, and I think we probably will," Mr. Sohn said, "then I think the Fed is significantly increasing the probability of an overkill."
Unfortunately, that would be not be a first-time event, the economist added. "It is how we have gotten into some of our economic recessions in the past." Mr. Sohn said his own inclination, were he a Fed policy maker, would be to hold rates at current levels and wait for further data before acting. With inflation seemingly restrained, he sees no need to hurry.
It would be safer to get to Fed Chairman Alan Greenspan's ideal GDP growth pace of 2.5% a little more slowly, Mr. Sohn said. "Trying to do it too quickly risks overshooting, sending the economy below that level and causing damage."
Nevertheless, Mr. Sohn expects key short-term rates to go up another 100 basis points this year, beginning this week.
"We are still going faster than Chairman Greenspan's speed limit of 2.5% growth, so he will probably be issuing more speeding tickets to us," the economist said.
Additionally, he said, the FOMC probably does not want to wait to act until its second meeting of the year, on March 28, or to have to debate the issue and act in a telephone conference call during the seven-week period between the January and March sessions.
The FOMC comprises Mr. Greenspan and the Fed's other board members in Washington, the president of the Federal Reserve Bank of New York, and selected other regional Fed presidents who serve on a rotating basis.
Overshooting with rates may be necessary to correct the Fed's past mistakes, according to James W. Coons, the chief economist at Huntington Bancshares, Columbus, Ohio. He also anticipates a 50-basis-point increase from the Fed this week.
"I think Alan Greenspan still sees price pressures lurking just beneath the surface," he said. "They are probably going to move up with rates and and I think that is appropriate."
Mr. Coons said he "had no problem with a 6.5% or 7% funds rate. It's not clear to me that this will cause a recession."
If rates remained at that level indefinitely, "maybe it would soften up the economy too much," but lowering rates again after an interval of six to nine months would probably ensure a soft landing, he said.
The current 5.5% funds target rate, up from 3% a year ago, is a basically neutral rate level that tilts only slightly toward a disinflationary monetary policy, in Mr. Coons' view.
Mr. Coons emphasized he was not advocating that the central bank attempt to fine-tune monetary policy, an exercise that most economists have come to think is neither possible nor desirable.
But the Fed should not have pushed the funds rate down to 3% prior to its renewed tightening campaign last year. Rather, it should have stopped at 4% several years ago and waited longer for the economy to respond with renewed expansion.
That monetary "policy error" has opened the door to inflation and now calls for further restrictive activity by the central bank as a correction, Mr. Coons said.
"Had they left it at 4%, they might have been able to get the shift they needed from the economy last year by moving up to 5%," he said. "Instead, they have now been faced with overshooting in the other direction to soak up some of the excess liquidity in the economy."
