Fed cut likely today Goal is to head off a credit crunch and avoid recession

Quarter-point? Half-point?

Experts disagree on the size of the reduction

Monetary policy

September 29, 1998|By BLOOMBERG NEWS

WASHINGTON -- Federal Reserve policy-makers are likely to cut borrowing costs today for the first time in 32 months in an attempt to forestall a global credit crunch that could push the U.S. economy into recession, analysts said yesterday.

Economies showed stress the world over in recent weeks.

Russia devalued its currency and defaulted on its debt; concern arose that Brazil might devalue; and Japan is mired in recession.

In the United States, the near-collapse of hedge fund Long-Term Capital Management LP -- which resulted in a Fed-brokered $3.5 billion rescue by its lenders -- raised doubts about the health of the financial system.

That adds up to the Fed cutting borrowing costs today, even as the U.S. economy holds its own, analysts said.

And it is a complete turnabout from a week or so ago, when Fed Chairman Alan Greenspan was only hinting at the first signs of "erosion" in the U.S. economy and most analysts expected that the strength of the U.S. economy would keep the Fed on the sidelines.

"The domestic case for a cut isn't there yet, but we're facing a more treacherous global growth picture and the risks to the U.S. economy have shifted," said James Glassman, economist at Chase Securities Inc. in New York.

"It's absolutely obvious that they're going to go."

What isn't as obvious is the size of the likely interest-rate cut. The Fed's policy-making Open Market Committee has kept the overnight bank lending rate at 5.50 percent since March 1997. While some expect the FOMC to cut the overnight rate by a quarter-point today, others look for a half-point cut.

That aside, there is less doubt about the direction of the Fed's action. Of the 32 banks and securities firms that deal directly with the Fed's trading desk, 30 expect a cut in the overnight bank rate tomorrow.

The view from Kodak

A rate cut would please some corporate executives because it would push consumer and business borrowing costs lower. "I've been saying for almost a year that the Fed should reduce rates," said Eastman Kodak Co. Chairman George Fisher.

"I hope we don't go into a recession, but who knows?"

Fisher's company had been reporting declining earnings for almost two years until the second quarter of this year.

How big the rate cut turns out to be -- or whether the Fed holds its fire -- could weigh on the market, analysts said.

"The markets have already priced in 50 basis points and will react negatively to anything less," said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc. in Chicago.

Greenspan called the economy "solid" in congressional testimony Sept. 16.

"Solid and even robust," said Kansas City Fed Bank President Thomas Hoenig, a voting member of the FOMC, on Sept. 18. "We have every reason to believe that economic growth will continue," said New York Fed Bank President William McDonough, vice chairman of the FOMC, in New York on Sept. 11.

Economic news has varied little since then. The economy has momentum, driven by the lowest unemployment and mortgage rates in a generation, a surge in consumer spending and a vibrant housing market.

Even so, by last Tuesday, the Fed's words were less sanguine. McDonough said in Vienna, Austria, that he expected the U.S. economy to grow at an annual rate of 2 percent to 2.5 percent in the second half of the year before slowing further in 1999. That is well below the 3.7 percent annual growth rate in the first half of this year.

Warning from Greenspan

Growth will slow because "there will be strong drag on the export sector and that will subdue growth in construction," McDonough said.

And Greenspan iced the cake Wednesday with an explicit warning to the Senate Budget Committee.

"Deteriorating foreign economies and their spillover to domestic markets have increased the possibility that the slowdown in the growth of the American economy will be more than sufficient to hold inflation in check," Greenspan said.

Pub Date: 9/29/98

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