With inflation low and the economy slow, the Federal Reserve may soon cut interest rates. If so, how much?
Quite a lot, and faster the many people think, some economists believe. A few think rates could be headed back toward 1993 lows.
"By the end of the year, the federal funds rate could be down to 4.5%," said Edward Yardeni, chief economist at C.J. Lawrence Deutsch Bank Securities Corp., New York.
"If economic growth responds well to this monetary stimulus, further Fed easing won't be necessary during the first half of 1996," he said.
"However, I suspect that the Fed might have to lower the federal funds rate all the way back down to 3% by the middle of next year to keep the economy growing above 2% in 1996," Mr. Yardeni said.
The federal funds rate, the overnight rate for interbank loans, is closely managed by the Fed and serves as the central bank's chief mechanism for carrying out monetary policy.
The Fed cut the rate to 3% in September 1992, a two-decade low, and held it there until February 1994 to stimulate the economy's growth out of a stubborn recession. Some economists think even that record could be breached next year.
"The preponderance of evidence will reflect a deteriorating economy,, so we now anticipate that the 30-year Treasury bond yield will break 6% and possibly fall further this year, even if there is no recession," said economist David A. Levy of the Levy Institute at Bard College, Annandale, N.Y.
"The Fed will be forced to cut short-term rates by a minimum of 50 basis points this year, and likely even more," he said last week in his Industry Forecast newsletter.
"If a recession is occurring, bond yields will fall below their 1993 lows," Mr. Levy said. "The result will be sharply lower rates, with the rate on 90-day Treasury bills falling to 2% to 3% next spring."
Economist Paul A. McCulley of UBS Securities, New York, thinks the Fed will ease credit as early as next month. "And we think that will be the first move in an easing process that will take the Fed funds rate to 4% within the next year."
"Certainly the (bond) market is saying 6% is too high, and that something closer to 5% is where the funds rate ought to be," said Sung Won Sohn, chief economist at Norwest Corp., Minneapolis.
Allan Sinai, chief economist at Lehman Brothers, New York, sees the Fed moving in the same direction, but not as far.
"The economy's slide, accompanied by data showing low inflation now and in the future, sets a very different backdrop for the Fed," he said.
"The economy is going to need some help. I think they will cut the funds rate by a quarter point in July and another quarter point in August," at the next two meetings of the Federal Open Market Committee, he said.
Others, however, expect the Fed to fly a monetary holding pattern as long as possible, bidding to drive inflation to near zero.
"We have a Greek chorus of Fed officials saying the fundamentals of the current economic expansion are sound, and that they are looking for a reacceleration of growth" noted Eugene Sherman of M.A. Schapiro & Co., New York.
"Even (Fed vice chairman) Alan Blinder, who had been seen as leaning toward easing credit, has retracted that view," he said.
Mr. Sherman thinks the inventory correction that has stunted the economy recently is occurring rapidly and that by later in the summer and into the fall we are going to see a fairly good reacceleration of growth."
If that happens quickly, Mr. Sherman rules out any easing by the Fed this year. But he noted that the central bank could well "step back and take another look" if weak economic reports continue to come in.
He added that there is "very little evidence right now of any reacceleration, but there is some preliminary evidence that the slowdown is abating."