WASHINGTON - Federal Reserve officials may soon have to abandon their neutral policy on short-term interest rates, given the latest evidence of a stronger economy that is creating more jobs, analysts said Friday.
Some analysts now believe members of the Federal Open Market Committee will adopt a policy directive that leans toward a tighter reign on credit when they meet Dec. 21. Such a move could set the stage for a move to raise rates some time early next year.
Their comments came after the Labor Department reported that the civilian unemployment rate plunged from 6.8% to 6.4% in November, the lowest level in nearly three years. The department's non-farm payroll survey showed 208,000 jobs were generated in a variety of industries, with a second month of increases in construction and manufacturing.
Administration officials welcomed the employment report. ~We are now in a jobs recovery," said Labor Secretary Robert Reich in a statement. Laura D'Andrea Tyson, head of the President's Council of Economic Advisers, was also upbeat in comments to reporters.
Fed officials have kept the federal funds rate unchanged at 3% since September 1992. But policymakers will find that too low if the economy keeps cooking at an above-trend growth rate because inflationary pressures would eventually follow, analysts said.
"The issue continues to be whether this rate of growth will be sustained in the first quarter. The Fed will want to see first quarter data before actually moving, but it's time for them to get ready?' said John Williams, managing director for CS First Boston.
Williams said he expects FOMC members "to cock the pistol" and seek to prepare the bond market for higher short-term rates, even though the inflation picture has brightened with the drop in oil prices. He estimated that this week's producer and consumer price reports for November will look "fantastic" with gains of 0.2% or less in both the overall indexes and the core rates excluding food and energy.
"Inflation follows rather than leads strengthening economic activity," Williams said. "If you wait until inflation begins, it's too late. You've already got entrenched forces that are very difficult to turn around."
Joseph Liro, senior vice president for S.G. Warburg & Co., is looking for the Fed to tighten monetary policy in February or March if officials get hard statistics pointing to economic growth of 3% in the first quarter. That would be below the estimated surge of 4% in the fourth quarter, but still above the economy's long-range potential growth rate of 2 1/2%, Liro said.
Short-term rates have already started creeping up amid expectations of a Fed tightening. The spread between the two-year note yield of 4.25% and the federal funds rate is now about 125 basis points, up from 100 basis points when the bond market was convinced that the Fed would remain neutral.
However, analysts are remaining cautious about the prospect of any Fed tightening because many expect growth to slow after the beginning of the year. As a result, some expect officials to play a sophisticated game of talking tough on inflation but holding off as long as they can from changing policy.
Financial markets are assuming that although we're having a growth-oriented spurt, it won't develop into sustainable above-trend growth," said Samuel Kahan, chief economist for Fuji Securities Inc. in Chicago.
Falling crude oil prices, low commodity prices, and tame wage pressures in the U.S. and overseas all point toward containing inflation, Kahan said. The factors should help keep short-term rates from moving up much, Kahan suggested. "The market is factoring in some firming of the funds rate over the next year, but nothing dramatic, maybe 50 basis points when all is said and done," he said.
In their mid-session budget review, administration officials built in a rise in the 90-day Treasury bill rates from 3.1% to 3.6%. Tyson said Friday that inflation still does not appear to be a problem, but she said the Fed must decide what to do on rates.
The drop in the unemployment rate to 6.4% marked a continuing declined from a high of 7.7% in June 1992. Analysts called the drop suspect because it resulted from a slight decrease in the labor force and a large gain in the number of employed workers as measured by the household survey. Moreover, the survey is due to be revised in January using a methodology that will probably boost the overall jobless rate.
Still, the non-farm payroll survey, which is separate from the household series, showed gains in most types of business. Construction jobs got a boost from strength in homebuilding, while manufacturing firms added jobs in furniture and other durable-goods industries. Labor officials said, Health and other service sector jobs rose by 105,000, half of the 208,000 total increase.