Fed Seen Staving Off A Rate Cut Until Its Sept 18 Meeting

Source : The Business Times, August 24, 2007

Meanwhile, it is gathering anecdotes from district banks, say Fed watchers

(WASHINGTON) Federal Reserve policy makers' uncertainty over the credit crunch's toll on US growth is making them increasingly unlikely to cut interest rates before their Sept 18 meeting.

Fed officials are gathering anecdotes from the dozen district banks to assess economic conditions, Fed watchers say.

The effort is needed because policymakers expect to learn little from government reports for July, such as durable-goods orders and new home sales, which will reflect conditions before a collapse in securities backed by sub-prime mortgages prompted a crisis of confidence in global markets.

Stocks rose on Wednesday as credit conditions eased, and yields on short-term Treasury notes fell as traders pared bets on an imminent reduction in borrowing costs. The four largest American banks each borrowed US$500 million from the central bank's discount window, a sign that Fed chairman Ben S Bernanke's strategy to provide liquidity without easing monetary policy is starting to work.

'They don't want to cut rates if they can avoid it,' said Joe Lavorgna, chief US economist at Deutsche Bank Securities Inc in New York. 'Things are moving in the right direction. Will it be enough? Maybe.'

By waiting until the September meeting, the Federal Open Market Committee will be able to review a new forecast. All five members of the Board of Governors will be present, along with the district bank presidents, research staff and New York Fed market analysts.

In the meantime, policymakers are focusing on such scraps of information as the availability of jumbo mortgages - those exceeding US$417,000 - for borrowers in specific cities.

'You man the phones,' said J Alfred Broaddus Jr, former president of the Richmond Fed, who was a policymaker during the 1998 global market rout. 'Anecdotal information is particularly important in these kinds of situations.'

New York Fed president Timothy Geithner, the central bank's chief liaison with Wall Street, holds a daily conference call with the board of governors and district bank presidents to brief them on developments. At a video conference on Aug 16, they decided to reduce the discount rate, the cost of direct loans to banks from the central bank, by half a percentage point to 5.75 per cent.

There are still signs of distress and the Fed's patience depends on markets settling down, Fed watchers say.

Investors demanded the highest yields in seven years to buy asset-backed commercial paper after H&R Block Inc, the biggest US tax preparer, said that a unit tapped credit lines because it couldn't sell short-term debt. Lehman Brothers Holdings Inc on Wednesday shut its sub-prime lending unit and said that it would fire 1,200 employees. HSBC Holdings plc closed a US mortgage office.

'They will use as much anecdotal information as they can get their hands on,' said former Fed governor Lyle Gramley, senior economic adviser at the Stanford Group in Washington. 'My judgment is that the Fed will cut the funds rate by 25 basis points on Sept 18, not before that unless markets require it.'

Fed officials acknowledged that the 'downside risks to growth have increased appreciably' as a result of financial turmoil in their Aug 17 statement, which updated their Aug 7 outlook.

Mr Bernanke has the ability to change the federal funds rate between meetings in consultation with the FOMC without calling a vote, a tool his predecessor Alan Greenspan exercised in 1998.

The current chairman has stressed that he wants authority to reside in the FOMC, not solely the office of the chairman.

That difference in approach suggests a preference for waiting until formal meetings before adjusting interest rates, Fed watchers say. -- Bloomberg