Analysts divided on whether Fed will raise rates

The Outlook

May 03, 1998|By David Novich

THE STOCK MARKET somersaulted last week, as speculation about the strength of the economy and the Federal Reserve Board raising interest rates boosted volatility.

On Monday, reports that the Fed would raise rates made the Dow Jones industrial average average fall nearly 147 points. By Thursday, the Dow had regained the loss amid growing confidence that the economy is not overheating.

The wild ride has some concerned that the market is overvalued and that it's only a matter of time before investors take a beating.

Others say the future of the economy is strong, and market fluctuations are just a daily part of life on Wall Street.

Is last week's volatility a harbinger of the market to come? Or will the Fed raise rates to give the economy a breather?

J. Patrick Bradley

Director of economic and investment research, Mercantile Safe Deposit and Trust Co., Baltimore

My best guess is that the Fed will raise rates in the second half of the year and most likely by a quarter of a point. The Fed does not want to push the economy into a recession, just slow conditions down a little bit.

On the one hand, the Fed is facing strong domestic conditions. But on the other hand, it is concerned about the prospect of deteriorating conditions in Asia and the recession in Japan spilling into America, which won't allow the Fed to raise rates.

I think most people were expecting the House to approve the additional $8 billion in funding for the [International Monetary Fund]. But since they didn't, investors in emerging markets have been hurt. And Japan's economy continues to languish because people don't think the stimulus program by the Japanese is strong enough.

[By the second half of the year], most of the Asian impact will have likely made its way through the economy, and the Fed will have to raise rates.

Chris Chmura

Chief economist, Crestar Bank, Richmond, Va.

I'm not expecting the Fed to raise rates this year. You have to remember, the Fed is not raising rates in reaction to what is happening in the market today, but what will happen a year from now. During that time, economic growth will likely slow down to 2.5 percent.

The economy has benefited from a lot of short-term positive impact in the first quarter. The very warm weather probably increased housing and retail sales, and, in a sense, stole away from growth in the second or third quarter. People bought warm-weather clothing in February that they would have bought later in the year.

Also, because of the Asian crisis, a lot of money went into the U.S. seeking lower risk alternatives, which helped support stocks and lower bond yields. The lower yields translated into a refinancing boom that gave people extra money to spend. Both of these factors were short term and won't continue to impact the economic growth after the first quarter.

We've also seen a lot of inventory building, and typically, when there's inventory building, we see a slowdown later.

Gordon Kroft

Vice president and director, Croft-Leominster Inc., Baltimore

Interest rates are not going to go up much from here because there will be a budget surplus and a shortage of long-term bonds, which will drive interest rates down, even if the Fed increases rates slightly.

The economy is still growing, and I don't see a recession on the horizon. The market hasn't corrected itself much from where it is now.

In the third or fourth quarter, the Fed will raise rates. And the market's going to fluctuate some, but it's not a real serious concern.

Mark Vitner

Vice president and economist, First Union National Bank, Charlotte, N.C.

I'm not certain if the Fed will raise rates, but if they do, it will only be small, and not until September.

The drop in the market, though, was not incorrect. Stocks have been too exuberant, and one of the reasons the Fed leaked the information was because there was too much optimism in the market.

People's expectations have to come back to earth. Corporate profits are likely to get squeezed soon because of the increase in imports from the Far East. At the same time, wages are accelerating and productivity growth is slowing. With all of these factors and the GDP up in excess of 3 percent, it is not a good situation for corporate America.

The Fed would like to see growth come down to 2 to 2.5 percent and may raise rates. But it's still possible that we haven't seen all the impact of Asia, and won't until late this summer.

Pub Date: 5/03/98

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