The Federal Reserve may be poised to begin cutting interest rates Tuesday, earlier than many observers had recently believed likely.
Reverses in the banking sector, deteriorating conditions in Latin America-where banks have major stakes-and the remarkable Fed-engineered bailout last week of a large hedge fund signal how far the fallout from financial market turmoil has spread.
"I thought the Fed might wait a bit longer on rates, but they may now perceive some risk to the banking system," said Springfield, N.J.-based economist and money manager A. Gary Shilling.
A Tuesday rate cut is now a 75% probability, he said.
Others are less sure. Nicholas S. Perna, chief economist at Fleet Financial Group, who has been forecasting since last November that the Fed's next rate move will be down, thinks Tuesday is a "close call," with chances of a cut at 40%.
Last Wednesday, Fed Chairman Alan Greenspan seemed to telegraph an imminent rate cut. In Senate testimony he expressed concerns about a laundry list of adverse international financial trends, including a reduction in bank lending that threatens a credit crunch.
Mr. Greenspan modified his usually elliptical style in answering a question about a Tuesday rate cut. "I can't comment at this particular stage on what particular action will or will not be taken," he said. "But I really would suggest to you that I think we know where we have to go."
Several small midwestern banks have apparently concluded that Fed action is at hand. Southwest Bank of St. Louis and West Des Moines State Bank of Iowa cut their prime rates. (See related story above.)
"The move was precipitated by falling commodity prices, falling bond yields, and low inflation," said Southwest Bank's chairman, Andrew N. Baur.
If the Fed does cut rates on Tuesday it will be acting without the usual burden of proof it requires for such action.
The central bank has always made a point of raising rates preemptively to neutralize inflation or prevent the economy from overheating, but many economists say it has been reluctant to ease credit until economic conditions were clearly deteriorating.
The U.S. economy itself remains strong, but growth is slowing and is projected to slow further. Economists at Merrill Lynch & Co. think output will expand just 1.5% in the current quarter, versus 1.8% in the second quarter.
But some signs of more pronounced weakness are also appearing. The most recent index of business conditions of the Federal Reserve Bank of Philadelphia fell sharply in August, with declines in new orders, unfilled orders, delivery time, inventories, and employee workweek.
Mr. Shilling, who heads his own consulting and management firm in Springfield, N.J., thinks the Fed may reduce the federal funds rate by a half percentage point, to 5%. Also expecting a half-point reduction is economist Paul A. McCulley of Warburg Dillon Read.
Sung Won Sohn, chief economist at Norwest Corp., Minneapolis, predicts Tuesday's Fed move will be a quarter point, with further moves to follow at central bank sessions in November and December.