Federal Reserve policymakers, apparently confident about the outlook for the nation's economy, opted Tuesday not to push short-term interest rates down further.

The central bank decision, issued without comment, surprised few bankers or Wall Street professionals, but some observers believe the Fed could and should provide easier credit.

The Fed last month reversed course and reduced rates a notch after an 18-month policy of tightening credit that Chairman Alan Greenspan said was necessary to thwart the rise of inflation.

The federal funds target rate was cut July 6 to 5.75%, from 6%, after having previously been doubled from 3% from February 1994 to February this year. Federal funds is the overnight interbank lending rate.

Former Fed vice chairman Preston Martin, who was a critic of Fed rate hikes made last November and February, said he believes rates must be cut further soon to ward off a possible recession next year.

Economist Edward Yardeni of Deutsche Morgan Grenfell/C.J. Lawrence Inc., New York, said recently that many key business cycle indicators have peaked, and he urged the Fed to "act now to avert a recession in 1996 or 1997."

And even economists who do not fear a recession note that inflation is extraordinarily quiet, which suggests the Fed could reduce rates with little fear of igniting worrisome price pressures in the economy.

The trend toward moderating inflation "appears to be fundamental and long-term," said Eugene J. Sherman, director of research at M.A. Schapiro & Co., New York, a broker-dealer specializing in bank securities.

The current inflation outlook "is more optimistic than at any time since the 1960s," wrote Mickey D. Levy, chief financial economist at NationsBanc Capital Markets Inc., New York, in a recent study. The company is a unit of NationsBank Corp.

From a more technical perspective, another analyst pointed out that the markets seem to be telegraphing that "real" interest rates, adjusted for inflation, are too high.

"The yield on the three-month Treasury bill has been moving within the 5.40% to 5.50% range since late June, or an average of 30 basis points below the federal funds rate target," said financial consultant Bert Ely.

"This recent experience contrasts sharply with the 15-month period from November 1993 to January 1995, when the yield on the three-month bill averaged seven basis points above the average funds rate target," he said.

That makes the gap between the yield differential in those 15 months and the differential in recent weeks almost 40 basis points, said Mr. Ely of Alexandria, Va.-based Ely & Co.

Clearly, the financial markets are continuing to reject the most recent increase in the federal funds target rate, he said. That occurred Feb. 1, when the rate went to 6% from 5.5%.

"The markets," he said, "are telling the Fed that the Federal Open Market Committee's rate signal, the funds rate target, is at least 25 basis points out of sync."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.