Fed sure to raise rates, but amount is in question

SUNDAY OUTLOOK

August 14, 1994|By Timothy J. Mullaney

The Federal Reserve's Open Market Committee will meet Tuesday amid widespread expectations that the Fed will raise interest rates for the fifth time this year. Some observers believe the Fed should keep rates low to stimulate growth, pointing to sluggish new home sales as a sign that the recovery is not strong enough to stand up to higher rates. But the bond traders and many economists want higher rates to check any inflationary pressures, pointing to last week's jump in the producer price index and worries about the future. Friday's report showing consumer prices increased moderately in July merely added to an unclear inflationary picture.

@4 So, what will the Fed do? And what should it do?

Paul W. Boltz

Economist,

T. Rowe Price Associates Inc.

I think the Federal Reserve will tighten monetary policy [this] week. If I were they, I would raise the Fed funds rate 25 basis points, or 1/4 percent, wait for more evidence on the economy's performance, and if it continues to look robust tighten further in late September, another 25 basis points.

They could raise both [the Fed Funds rate and the discount rate], but for the market, the overwhelming rate is the Fed funds rate. The discount rate applies to only a small amount of lending; the Fed funds rate is the key overnight rate in the U.S. and all other short-term rates are keyed to it.

You raise the discount rate to make sure the change makes the evening news, but in recent years the Fed funds rate has been plenty.

The economy has reached full employment and slack in the economy is rapidly disappearing. It's important for the Federal Reserve to slow the economy down to its long-term trend rate of growth soon or we will have drum-tight labor markets, rising commodity prices and all the rest.

David L. Donabedian

Economist,

Mercantile Safe-Deposit & Trust Co.

It's not always the case, but I think what they will do and what they should do will be the same thing. I believe they will vote to raise interest rates.

I tend to lean toward a half-a-point increase in the Fed funds rate, and the discount rate will go along with that. We're headed in that direction anyway, whether they do it in two steps or one. I think the probability of that has increased just in the last week, as we saw strong employment figures for July. Just [Thursday], we saw a good report on retail sales. Mercantile's forecast all along has been that the inflation figures would be well behaved in the first half and would start to move higher in the second half.

You can make a case for energy prices being a consistent contributor to inflation in the next several months. Oil prices are up 50 percent from their lows. . . . You continually see rising forecasts for energy demand around the world. France and Germany are starting to come out of their recessions, which will push energy demand higher.

I don't know if we're at full employment, but we're not too far from it. We've seen a pretty significant increase in commodity prices, and with global growth the risk of further increases goes up.

The other thing is, what's really going on here is that until the employment number last week you had a quick consensus that the economy was going to slow significantly in the second half of the year, which is what the Fed and the markets wanted. Our view has been that you wouldn't see a substantial slowdown; some of the weakish economic numbers of the last few months are a normal transition in the economy as some of the consumer sectors slow down but some other [mostly industrial] sectors pick up. . . . We think the growth is going to be a little too good for the Fed's liking.

Richard J. Paget

Head of Municipal Bond Dept.,

Alex. Brown & Sons Inc.

The most recent spate of numbers on employment were fairly strong numbers. [Inflation] is under control, but we're coming out the other side of the business cycle, and when you get there, there are inflationary pressures. In the latest beige books, three out of 12 Fed districts reported there are beginning to be shortages, especially of skilled labor. . . . Most people think [factory utilization] is right on the cusp; if it gets any higher it will push it.

It ain't here yet, but there are enough signs that, as Greenspan said, they want to err on the side of caution.

The market, the source of all wisdom in our business, has factored in a 25-basis point rise on the 16th. The debate is whether it should be 25 or 50. Twenty-five seems about right to assure reasonable growth through the end of the year. . . . The thing that bothers me the most is primarily shortages, especially of skilled labor in industries like construction, which accounted for the big boost in hourly earnings in the last report. . . . It's enough to make you forget about the addition on the house for a while.

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