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US Fed Expected to Cut Interest Rates to 2% on Wednesday

Interest-Rates / US Interest Rates Apr 28, 2008 - 10:42 AM GMT

By: William_Patalon_III

Interest-Rates

Best Financial Markets Analysis ArticleU.S. Federal Reserve policymakers will likely cut its key interest rate to 2.0% from 2.25% this Wednesday, which would mark the seventh such move since the central bank launched its rate-reduction campaign in mid-September.

But if the central bank does pare short-term interest rates, it's likely to be the last such move in awhile; the Fed will take a break and give its rate cuts a chance to work their way through the U.S. economic system.


Despite an active-economic-calendar schedule this week - which includes a report on first-quarter gross-domestic product, and several other statistics that could confirm that the U.S. economy is entrenched in a recession - the Fed's machinations should dominate this week's headlines, given that the central bank's interest-rate-setting arm is set to meet Tuesday and Wednesday.

Any announcements about interest rates will be made at 2:15 p.m. Wednesday. Experts also say that whatever the Fed says about its expectations will be just as important as what it actually does to the benchmark Federal Funds rate.

"I don't think there's any question that they'll cut [a quarter-percentage point] off the rate," David Rosenberg, chief economist for Merrill Lynch & Co. Inc. ( MER ), told The International Herald Tribune . "The real question is what they say about the future. It won't be an ‘all clear' signal. But they'll find a way to tell the markets that they've done enough for now, simply put."
Not everyone agrees.

"There is no reason why the Fed should be cutting rates right now," Richard Yamarone, director of economic research at Argus Research Corp., told MarketWatch.com .

Yamarone may be thinking back to some of the public comments certain of the central bankers themselves have been making.

Back on April 18, Fed officials hinted that they would be reluctant to cut the benchmark Federal Funds rate yet again, given that the slumping U.S. economy also faced a major inflationary threat. Indeed, Philadelphia Fed President Charles Plosser warned against believing that interest-rate cuts were "the solution to most, if not all, economic ills."

Plosser is one of the Fed's major anti-inflation hawks At the time, Plosser was merely the latest in a string of policy-makers to warn about the rising risks of inflation, essentially suggesting that another rate cut would probably be a very tough sell.

In a speech at Drexel University's LeBow College of Business in Philadelphia, Plosser said real interest rates were now at "an accommodative level, meaning borrowing costs were low enough to start boosting the U.S. economy's growth rate back toward its normal historical norm, Reuters reported .

The futures market is projecting a Fed Funds rate of 1.75% by the end of this year. Here's a look at the futures market's month-by-month expectations for short-term borrowing costs for the remainder of 2008:

  • April: 2.17%.
  • May: 1.89%.
  • June: 1.85%
  • July 1.79%.
  • August 2008: 1.76%.
  • September 2008: 1.76%.
  • October 2008: 1.77%.
  • December 2008: 1.73%.

The worries about inflation that Plosser and other inflation hawks have are very real. And those concerns don't exist solely on our side of the Atlantic. The low U.S. rates are contributing to a weakness in the greenback that's sent the American currency to record lows against most other key world currencies. That's fueling a massive run-up in the cost of energy and food-related imports - and that's inflationary for U.S. buyers.

But it's made U.S. exports very competitive abroad, acting almost as a big discount for foreign buyers of such wares as Boeing Co. ( BA ) jetliners. In fact, just last week Boeing surprised Wall Street with record earnings and announced a record order backlog. And pan-European arch-rival Airbus SAS ., was forced to announce a price increase on several  of its commercial airliners - because of rising steel prices and because of the falling dollar.

French Economy Minister Christine Lagarde yesterday (Sunday) that the gap between the U.S. and Eurozone interest rates was way too large, and called for a change in rate policies on one side of the Atlantic, or the other.

"We are in a delicate situation where we have, on the one hand, an American Federal (Reserve) which has a policy of very low rates and a European Central Bank which has maintained high interest rates," Lagarde told LCI Television and RTL Radio , the global wire service Reuters reported . "The differential in interest between the two, it seems to me, is a little too big at the moment."

Paris has long been a vocal critic of what French President Nicolas Sarkozy has termed the ECB's overly narrow focus on fighting inflation - and has previously been criticized by Germany for meddling in the business of the "independent" central bank.

With Eurozone inflation running at about 3.6% - its highest rate since the measure for that portion of the European market began in 1997, the European Central Bank (ECB) has left its key refinancing interest rate unchanged at 4.0%, despite some very definite signs that Eurozone growth is slowing.

By comparison, the key U.S. interest rate is at 2.25%, though it may be heading lower this week, and inflation is "officially" said to be at right about 4% - though such experts as Money Morning Contributing Editor Martin Hutchinson believe the actual U.S. inflation rate is actually much higher .

Although the FOMC meeting is likely to top the economic the economic news of the week this week, the GDP report will come in a fairly close second and will be nearly as closely watched by some experts. The reason: Many eternal pessimists are expecting the report to show negative growth during that three-month period.

Why is that important? Simple: According to the National Bureau of Economic Research (NBER), two consecutive quarters of negative growth constitutes a recession.

Most folks "feel" like the U.S. economy is already in a recession. An official designation by the NBER - which usually comes well after the fact - would simply make it official.

In the meantime, some of these other reports this week could help serve as an interim and unofficial "confirmation" of that dour diagnosis of the U.S. economy:

  • The health of the manufacturing sector will get a solid assessment via Thursday's release of the much-watched ISM survey and Friday's report on factory orders.
  • The all-important U.S. labor markets will get significant scrutiny via Thursday's report on initial jobless claims and Friday's reports on the U.S. unemployment rate and on non-farm payroll data.
  • We'll get a bit more insight into the psyche of the American consumer with Tuesday's report on consumer confidence for the month of April and Thursday's report on personal income and spending for the month of March.
  • And we'll get an overview of Corporate America's health, as U.S. energy giants Exxon Mobil Corp. ( XOM ) and Chevron Corp. ( CVX ) reveal how their profit reports have been boosted by record energy prices [likely also prompting new calls for Congressional investigations into allegations of price gouging].  Starbucks Corp . ( SBUX ) will follow up recent warning with an actual announcement, while Office Depot Inc. ( ODP ) and Radio Shack Corp. ( RSH ) will give investors a look inside the world of retail.

Market Matters

Two weeks ago, investors disregarded any semblance of bad news (and lately, there has been plenty) and instead took the stock indices to their highest levels in months. Last week, investors allowed the earnings releases to guide their trading activities while awaiting the Fed's interest-rate decision and commentary.

So just what did the recent earnings reports say about the current state of Corporate America?

Financialscontinue to stoke the negativity (no surprise there) with Bank of America Corp. ( BAC ) , investment banker Credit Suisse Group ( CS ) , and bond insurer Ambac Financial Group Inc. ( ABK ) reporting more disappointing results.  Drugmakers, on the other hand, enjoyed a nice quarter with Merck & Co. Inc. ( MRK ) and Novartis AG ( NVS ) beating expectations.  While a sluggish economy can't keep folks out of McDonald's Corp. ( MCD ) (as least in its international markets), it does seem to be impacting coffee intake as Starbucks warned that this week's results (and those for all of 2008) will miss earlier projections.  Of course, dire times lead to more nervous smoking (and higher cigarette sales) as happy Philip Morris International Inc. ( PM ) shareholders found out this quarter.  While cost-conscious folks stayed home and watched more DVDs, Netflix Inc. ( NFLX ) warned that future subscriber growth may be limited. 

Both Delta Air Lines Inc. ( DAL ) and Northwest Airlines Corp. ( NWA ) posted sizable losses on skyrocketing fuel costs, leading some analysts to question the wisdom behind the proposed merger. While the world's largest shipper, United Parcel Service Inc. ( UPS ), experienced a jump in profits, management expressed concern about the quarters to follow, since consumers just don't seem quite as interested in finding out " what Brown can do for you ."  Even techs, which previously had been a savings grace for the market, turned pessimistic this week.  Apple Inc. ( AAPL ) and Texas Instruments Inc. ( TXN ) reported decent earnings, but warned about their respective outlooks.

Likewise, high-tech bellwether Microsoft Corp. ( MSFT ) disappointed with its profit numbers, while investors wait with trepidation to see what becomes of Microsoft's bid for Yahoo! Inc., ( YHOO ). Meanwhile, Yahoo beat "The Street's" expectations. However, the three-week deadline that Microsoft gave Yahoo to come to an agreement on its unsolicited bid passed Saturday without any announcement from either side, leading to the possibility that the battle for Yahoo is about to turn hostile, MarketWatch.com reported .

ConocoPhillips ( COP ) showed that record energy prices are not hurting everyone, as the No. 3 U.S. oil company reported a 17% increase in profits. 

Transactions typically imply growing confidence in corporate boardrooms as management finds the value in certain acquisition targets.  Last week, News Corp. ( NWS.A ) moved closer to buying Newsday and giving Rupert Murdock greater control over the New York press .

Insurance giant Liberty Mutual Holding Co. Inc . agreed to buy SAFECO Corp. ( SAF ) in a $6.2 billion deal that will create the 5th-largest property and casualty firm.  Triarc Cos. Inc . ( TRY ) soon may be adding those terrific "hot-and-juicy" square burgers and addictive Frosty drinks to its Arby's roast-beef-sandwich menus as it looks to acquire Wendy's International ( WEN ) in a deal valued at $2.34 billion. And, of course, there's still the Microsoft-Yahoo proposal.

With a mixed week on the earnings front, stocks traded relatively flat as investors took some profits from last week's newfound bullish sentiment, while still searching for a bargain or two. 

Market/Index Year Close (2007) Qtr Close (03/31/07) Previous Week
(04/18/08)
Current Week
(04/25/08)
YTD Change
Dow Jones Industrial
13,264.82
12,262.89
12,849.36
12,891.86
-2.81%
NASDAQ
2,652.28
2,279.10
2,402.97
2,422.93
-8.65%
S&P 500
1,468.36
1,322.70
1,390.33
1,397.84
-4.80%
Russell 2000
766.03
687.97
721.07
721.88
-5.76%
Fed Funds
4.25%
2.25%
2.25%
2.25%
-200 bps
10 yr Treasury (Yield)
4.04%
3.43%
3.74%
3.87%
-17 bps

Economically Speaking

For many Fed-watchers, the prospect for another rate cut has been a foregone conclusion.  After all, central bank Chairman Ben S. Bernanke and clan have let their creative juices flow [not to be confused with the creative juices of those Wendy's hamburgers] over the past few months; the Fed has tried everything from the aggressive rate-cutting campaign to liquidity injections to arranging the buyout of The Bear Stearns Cos. Inc. ( BSC ) by JPMorgan Chase & Co. Inc. ( JPM ).

Suddenly, some great prognosticators believe the Fed may be "seven and done" as they drop the Federal Funds rate again (by a minimal quarter of a percentage point this time around) - before going on a "summer hiatus" to give their earlier work the time to take effect.

With oil prices hovering around the (once unheard of) $120/barrel level, some policymakers are sure to claim that inflation should be considered as critical a concern as the sluggish housing market to the U.S. economy's health. Indeed, comments such as those of Philly Fed President Plosser make it clear that inflation is already becoming an increasingly important consideration.

Additionally, the European Central Bank seems content to keep its lending rate at 4%, so further Fed actions will continue to have devastating impact on the value of the dollar.

The economic calendar was relatively light last week as analysts rested up for this week's vast array of important data. After a surprising climb (better known now as an aberration) in February, existing home sales plunged again in March, while new homes sales fell to their lowest level in more than 16 years.

Furthermore, the median price of a new home dropped by more than 13% last month, the largest such decline in almost four decades.

Durable goods orders fell in March, as well, although once the volatile transportation sector was removed from the equation, the results did not look half bad. 

We hope that investors and analysts got plenty of rest over the weekend to get ready for the bustle of economic reports due throughout this week. Talk of recession should resume with the release of the first-quarter GDP, which many eternal pessimists believe will show negative growth during that three-month stretch.

Weekly Economic Calendar

Date
Release
Comments
April 22 Existing Home Sales (03/08)

Decline implied that rise in February was an aberration

April 24 Durable Goods Orders (03/08)

Slide in transportation orders offset other gains

Initial Jobless Claims (04/19/08)

Large, unexpected drop in benefits claims

New Home Sales (03/08)

Worst showing in 16.5 years

The Week Ahead
April 29 Consumer Confidence (04/08)
April 30 GDP (1st qtr)
Fed Policy Meeting Statement
May 1 Initial Jobless Claims (04/26/08)
Personal Spending/Income (03/08)
Construction Spending (03/08)
ISM - Manu (04/08)
May 2 Unemployment Rate (04/08)
Nonfarm Payroll Additions (04/08)
Factory Orders (03/08)

 

News and Related Story Notes :

By William Patalon III
Executive Editor

Money Morning/The Money Map Report

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