Fed may hold off cutting interest rates

By Andrew Countryman
Chicago Tribune

As Federal Reserve policy-makers gather today, the question on many minds isn't so much what's next, but more along the lines of what's left.

Although surprisingly weak economic data of late sparked speculation that chairman Alan Greenspan and crew may cut interest rates yet again, the conventional wisdom is that they'll hold off, at least for now.

Many in the no-change camp, along with those expecting a cut, see a case for lower rates, saying it's primarily uncertainty over the situation in Iraq that will keep the Fed intently watching from the sidelines.

But with the target fed funds rate already at 1.25 percent — the lowest in four decades — and some economists predicting deeper cuts this spring, analysts are examining what tools the Fed would have left if the economy continues to resist efforts to prod it into full-blown recovery.

And, more to the point, would any of them make a difference?

"I suppose that every basis point helps some way, but I'd say we've all but lost traction from the Fed easing. ... What do you do for an encore?" said David Rosenberg, Merrill Lynch's chief North American economist, who nonetheless is among those predicting a cut today. "It's hard to imagine the Fed is going to be the cure this time around."

Indeed, Fed policy-makers have sent rates tumbling a Nasdaq-like 80 percent in just over two years, and still employers are shedding tens of thousands of jobs a month and rumblings are growing that the economy may be headed for the dreaded double-dip recession after all. If that happens, or if the economy just continues to languish, don't expect Greenspan to ride to the rescue.

"At this point, it's unclear what Fed policy-making can do. The problem now is not high interest rates," said Gus Faucher, senior economist at Economy.com. "We're talking about a $10 trillion economy. ... It kind of has a mind of its own. You can nudge it, but it's difficult to change directions."

Most experts agree the Fed still has some room to lower rates. Lehman Brothers economists are among the most aggressive, predicting a half-point intermeeting cut in April and a quarter-point cut at the May 6 meeting, bringing the rate down to 0.50 percent.

"I suppose they could cut to zero, but I think that's unlikely," Faucher said.

Whenever the Fed decides enough is enough, that doesn't render it powerless. It could, for instance, further reduce borrowing costs by buying longer-term Treasury bills and bonds.

Some experts said the Fed's real weapon would be time.

Mark Vitner, senior economist at Wachovia Securities, said that while attention has been focused on how far rates have fallen, it's only recently that inflation-adjusted rates have fallen below zero. In past recessions, he said, real rates were below zero for months at a time, and took many more months to do the trick. "I don't think monetary policy has been all that easy ... as widely believed," he said.

Although the economy continues to sputter, Vitner doesn't believe the Fed's dozen cuts since January 2001 have been ineffective, saying they have cushioned the downturn and "provided the foundation for a meaningful recovery once confidence returns."

That's why he believes Greenspan will be careful before cutting rates for fear of overstimulating the economy just as it begins to rebound.

"We're not suffering from a lack of liquidity. We're suffering from a lack of confidence," he said. "We're poised to recover once we get rid of this uncertainty."

That, in a nutshell, is the optimistic take on the economy. It was echoed yesterday by University of Michigan economists, who, in their annual forecast, said a fairly quick war could unleash growth of more than 5 percent in the third quarter and more than 3 percent in the fourth, with growth reaccelerating in 2004.

The other side wonders if Iraq is really the problem. Rosenberg, for one, said the combination of Fed monetary policy and government fiscal stimulus is at its most accommodative in the post-war era. The weakness is more fundamental than mere uncertainty, he said.