Fed prepared to cut rate

By Pamela Yip and Anuradha Raghunathan
Dallas Morning News

The Federal Reserve, trying to spur the economy into recovery and avoid the perils of deflation, stands poised to cut a key interest rate for the 13th time in 30 months at its two-day meeting starting today.

Led by chairman Alan Greenspan, the Fed began cutting interest rates in 2001 after the tech bust started a drag on the economy. The lower rates are credited with persuading consumers — and particularly home buyers — to continue keeping the economy moving.

The cuts have tapered off as interest rates have reached historic lows. And more and more, experts are expressing concern that continued cuts will have less than the desired effect on some areas of the economy and painful side effects on other areas.

"I recommend that the Federal Reserve not do anything," said Sung Won Sohn, chief economist at Wells Fargo Bank in Minneapolis. "In fact, it could do more harm than good. It could actually fan deflation psychology, causing people to postpone purchases."

Hardest hit are people who rely on savings in certificates of deposit or money market funds to supplement their income, such as retirees.

Greenspan began hinting at the possibility of a rate cut a few weeks ago, and stock analysts say the market has risen on the expectation of a cut helping the economy and companies' bottom lines.

The federal funds rate now stands at 1.25 percent. Analysts had been expecting a cut of 0.5 percent, or 50 basis points, but recent positive economic reports have pushed the forecast lower. The consensus seems to be for a 25-basis-point cut, judging by the federal fund futures traded on the Chicago Mercantile Exchange.

The Fed will announce its decision tomorrow afternoon.

Savers, who have taken it on the chin from vanishing savings yields, can expect lower rates to throw them another left hook.

The area most acutely affected is money market mutual funds, whose fees are in danger of exceeding their returns.

As of last week, the average seven-day simple yield for taxable money funds slipped to 0.67 percent — an all-time low, according to the Money Fund Report from iMoneyNet. Many funds are waiving fees to keep yields from falling into the minus category.

Several experts said that piling on one more rate cut to low rates is not going to do much for consumers. The market has zero percent financing on auto loans and the lowest rates in decades on mortgages.

However, consumers who have loans with variable rates — some credit-card loans, adjustable-rate mortgages and home equity lines of credit — can expect a marginal drop in rates.

Unless underlying business fundamentals improve, another cut won't have much of an effect on businesses' spending or their bottom lines, some experts said. However, like consumers, businesses with good credit standing do benefit, because their debt gets cheaper.

But several experts say that business spending will pick up only if business picks up.

Mortgage rates are not directly tied to the federal funds rate, and a rate cut won't necessarily drive down mortgage rates.

Housing industry experts say they expect the market to stay strong regardless of any Fed action.