Markets Bank On More Cuts As Fed Debates Recession Odds

Source : The Straits Times, Jan 30, 2008

WASHINGTON - AMID high expectations for another rate cut to help shore up an economy battered by housing and credit ills, the Federal Reserve was set to conclude a two-day policy meeting on Wednesday.

The Federal Open Market Committee was set to announce a decision around 1915 GMT (3.15am Thursday Singapore time). Most analysts were expecting a cut in the federal funds rate, with many predicting a half-point reduction.

The meeting was expected to see heated debate on the economic outlook in view of a global stock market swoon and heightened recession fears that prompted the Fed to slash rates by 0.75 per centage points in an emergency move last week.

Last Tuesday's rate move placed the federal funds rate at 3.5 per cent, and was the fourth cut since Sept 18, when the rate was 5.25 per cent.

The cuts in the federal funds rate, used for overnight interbank loans, can help lower a wide range of borrowing costs for consumers and businesses, and as such can help spur economic activity.

David Kotok, chief investment officer at Cumberland Advisors, said the Fed has sent a signal that it would cut by another 50 basis points this week through its special auction aimed at improving financial market liquidity.

The Federal Reserve said on Tuesday its auction resulted in US$30 billion (S$42.8 billion) in bids accepted at an interest rate of 3.123 per cent. The minimum bid rate was 3.1 per cent.

Mr Kotok said the Fed would be in an awkward position if it fails to lower its federal funds rate below the rate of the auction.

'To be consistent, the Fed must cut the fed funds rate by at least 50 basis points on January 30,' he said in a note to clients.

'If it cuts less than 50, it will have created a bidding situation in which US$30 billion was potentially loaned at a subsidy rate and not a penalty rate.'

Heightened fears of recession
The meeting comes amid heightened fears of recession in the world's largest economy, which has been buffeted by the worst housing slump in decades that has spilled over to the financial sector.

The International Monetary Fund said in a report on Tuesday that the US economy will slow but stopped short of projecting a recession. It predicted growth averaging 1.5 per cent for 2008 in an update of its twice-yearly World Economic Outlook.

The latest US economic data on Tuesday was mixed, potentially complicating the task for the Fed.

One report showed orders for durable manufactured goods surged 5.2 per cent in December, suggesting the factory sector is not as weak as some had anticipated.

'How will the Fed balance this report? It might make it cut rates by less but I still expect a rate cut,' said Robert Brusca at FAO Economics.

Merrill Lynch economist David Rosenberg said the durable goods figures 'suggest that the business sector is holding in relatively well' but that he still expected a half-point cut.

'We still believe that a 50 basis-point cut is the most likely outcome as the Fed's main concern is the deepening housing recession,' Mr Rosenberg said.

Joel Naroff of Naroff Economic Advisors said the Fed has put itself in a box where it may be forced to cut even though some members may be opposed, and before the Fomc sees data on US payroll growth in January in a report due Friday.

'When the Fed announced the emergency move last week, I didn't think the Fed wanted to cut again this week,' Mr Naroff said.

'Instead of satisfying the market beast, it only added to the blood thirst and another 50 to 75 basis-point reduction was immediately priced in. Now the Fed is in a bind. It will not have the January employment report before the decision is made and as I have argued consistently, it is all about jobs. What happens if there is a decent jobs report?'

Meanwhile the Conference Board's survey of consumer confidence fell 2.7 points to an index reading of 87.9, suggesting upcoming weakness in consumer spending, a key driver of the economy.

Mr Naroff said the survey seems to imply 'that households may be reacting to the stories about a recession being imminent rather than seeing it in their own workplace.' -- AFP