WASHINGTON -- Federal Reserve officials can be counted on to keep monetary policy locked in neutral all summer and perhaps longer as evidence accumulates that the U.S. economy is on the mend, financial analysts said Friday.
"The Fed is on hold," said Darwin Beck, director for First Boston Corp. "Any vestiges of belief that the Fed might ease further have been eliminated, and now the question will focus on what kind of recovery we are going to have."
The view that the economy is bottoming out and on the verge of expanding after a recession that began last July got a big boost with the employment report issued by the Labor Department. Although the reported showed the jobless rate climbed back to 6.9% in May, based on the department's household survey, a separate survey of businesses indicated nonfarm payrolls increased 59,000, the first advance since last June.
The report, coming on top of other economic indicators last week and guardedly optimistic comments by Federal Reserve Board Chairman Alan Greenspan, sent the bond market tumbling again. Yields on the Treasury long bond flirted with 8.5%, up from the previous week's close of 8.22%.
"The bond market is telling the Fed that despite the recession it is not convinced inflation is under control, and with a rebound in the economy inflationary pressures will begin to build again," said Mr. Beck. First Boston is forecasting that inflation-adjusted output of U.S. goods and services will rise at an annual rate of 2.0% to 2.5% in the second half.
"The Federal Reserve is in a do-nothing mode at least until Labor Day," said William Hummer, partner with the brokerage firm of Wayne Hummer & Co. in Chicago. "It's more than a wait-and-see situation where they monitor things and are prepared to adjust policy. There's nothing for them to do. They might as well go on vacation."
Mr. Hummer attended the international monetary conference last week in Osaka, Japan, where he heard Mr. Greenspan say he saw signs that business liquidations of inventories will come to an end soon and lead to stepped-up production. Mr. Greenspan also said he expects inflation to remain subdued -- a comment the bond market ignored.
"The market is hyper-nervous," said Mr. Hummer. "Greenspan wen out of his way to say that there may be a stronger-than-expected recovery, but that doesn't mean there's going to be an acceleration of inflation."
However, Mr. Hummer said the view of many bankers at the conference is that low inflation will not pave the way for lower bond yields. Rising demand for capital in the Middle East and in Europe while Germany and Japan shift capital to meet their own investment needs will be a problem for the market, as will Treasury's huge borrowing needs in the second half of the year, he said.
Many analysts believe any recovery will be weak because of high household debt levels, weak real estate markets, and other factors.
"The question remains how strong and long lasting will be the recovery that appears to be under way," Manufacturers Hanover Securities Corp. told clients in a market letter. "At best, we view the strength of the upturn to be anemic. At worst, the economy is headed for a 'double dip,' where higher interest rates ... push many sectors back into recession."
Paul Boltz, vice president for T. Rowe Price Associates, was less pessimistic. "The size of the backup in yields is not going to imperil an economic recovery," he said, noting that in the late 1980s long bond yields generally stayed between 8.5% and 9.0%.
The Labor Department report hinted at signs of recovery in construction and manufacturing, two pockets of the economy that have been mauled by large job losses during the recession. Manufacturing jobs increased with the help of gains in the automobile industry, and construction jobs increased for the second month in a row.
In the service-producing sector, jobs increased by 40,000. Gains came in health and government services, and business services advanced for the second month in a row.
The Labor report also showed that the average work week increased to 34.3 hours from 34.0 hours while average hourly earnings rose to $10.32 from $10.28, a healthy gain of 0.4%. Analysts said those figures suggested gains in personal income, which is needed to fuel consumer spending, and in industrial production.
"The economy has troughed pretty much across the board as far as I'm concerned," said Alan Lerner, manager, managing director for Bankers Trust Co. "The worst is over."
"This leaves the Fed with an unchanged policy and feeling comfortable about it," Mr. Lerner said. "They could stay that way right through the end of the year. There'll be no change in policy unless the economy slumps again, which is unlikely, or unless the economy takes off, which is unlikely."
A separate report from the Fed suggested consumers may be getting more confident about spending. The report showed that consumer installment credit jumped 2.8% in April, the first advance all year.