Goldman Sachs sees further Fed cut
By Heather Bandur and David Wells
Bloomberg News Service
NEW YORK — Goldman, Sachs & Co. became the first major Wall Street bond dealer to predict the Federal Reserve will lower interest rates this year to prevent the world's biggest economy from falling back into recession.
The Fed is likely to cut the 1.75 benchmark overnight rate by at least a half-point and as much as 1 point in the fourth quarter, according to Goldman Chief Economist William Dudley. That would put the rate at its lowest level since the 1950s.
The forecast is a 180-degree reversal for Goldman from five weeks ago. On July 1, the third-biggest U.S. securities firm predicted the Fed would raise the overnight rate a half-point this year after 11 reductions in 2001. The switch underscores growing concern that tumbling stocks, weak manufacturing and slow job growth will sink the economy into recession for the second time in two years, referred to as a "double-dip" by economists.
"The economy's going to be weaker than the Fed expects, the unemployment rate's going to rise and, in that environment, we think the Fed will want to take out insurance to guard against a double-dip," Dudley said. He cut his economic growth forecast for the fourth quarter to 2 percent from 2.5 percent.
Yields on Treasury notes and interest-rate futures tumbled as some traders stepped up bets that the Fed will cut rates as soon as this month's policy meeting.
The yield on the most widely traded two-year note dropped 14 basis points to 1.98 percent, the lowest level since the government began selling the securities in the 1970s.
The Fed is slated to hold two more meetings this year after September — in November and December.
In a Bloomberg News survey two weeks ago, none of the 22 firms that trade with the Fed, known as primary dealers, forecast a rate cut. Half predicted a rate increase before year-end on expectations the recovery would strengthen in the second half. The Fed is slated to next meet on Aug. 13.
Some said a rate cut would be a mistake.
"It evokes the image of ultra low rates of Japan, a stumbling economy, and the inability to stimulate consumer demand," said Robert Alley, who oversees the $9.25 billion in bonds at AIM Management Group, Inc. in Houston. "It would indicate the perception of economic weakness."
Goldman is alone among the 22 primary dealers that trade directly with the Fed in predicting the central bank will cut rates to 1 percent. Robert DiClemente, chief U.S. economist at Salomon Smith Barney Inc. assigns a 50 percent probability to a half-point reduction, which would lower the target for overnight bank loans to 1.25 percent. Neal Soss, chief economist at Credit Suisse First Boston, sees little chance the Fed will cut rates.
"There are two risks: One, you ease and people interpret the situation as much worse than they feared and you undercut business confidence you tried to build," Soss said. "Two, you ease and the reaction is ho hum; you have cemented the sense that you are in a world of trouble."
Government and industry reports this week have indicated the recovery is faltering. The economy grew 1.1 percent in the second quarter, less than half the rate forecast. Manufacturing and jobs growth weakened in July, suggesting the slowdown is extending into the third quarter as a tumble in stocks erodes confidence. The Standard & Poor's 500 Index has fallen 25 percent this year amid corporate accounting scandals.
"The stock market is a huge negative," Dudley said. "We've never had a stock market that's behaved like this at this point in the economic cycle; at this point it should be up, not down."
Most economists agree that the economy began expanding again around the start of the year after falling into recession in March of last year.
Robert Parry, president of the Federal Reserve Bank of San Francisco, said he sees little chance the economy will slip back into recession.
"I don't still think there's a high probability or even a significant probability to what is often referred to as a double dip," Parry told business leaders in Portland, Ore.
