Hopes rise that interest rates will retreat

After six rate hikes, the Fed may reverse course, say a growing minority of experts.

By , Staff writer of The Christian Science Monitor

After hiking interest rates six times since June 1999 to slow the US economy and deter inflation, the Federal Reserve may be poised to reverse direction, cutting interest rates late this year or early in 2001.

That view, while still in the minority, is gaining credence on Wall Street - bringing tentative smiles to debtors, auto-loan candidates, and homeowners. The signs of an economic slowdown, say those who anticipate a rate cut, will propel the Fed to flip its position.

Most Fed-watchers have not shifted that far. They are expecting simply that there will be no change in short-term interest rates for the rest of this year.

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Fed policymakers left rates unchanged in August. When Fed officials meet again Oct. 3, a month before the general election, they are widely expected to hold rates at current levels.

But the latest economic indicators, which some interpret as signs of a more modest pace of growth, are giving fresh hope to those who'd like to see interest rates drop.

"Now that we have become converts to the idea that economic growth is in the midst of a significant ... slowdown, it is only a short journey to the belief that the Federal Reserve is likely to start cutting rates late this year," says Charles Blood, investment strategist for Brown Brothers Harriman, an investment bank in New York.

Indeed, inflation remains modest, despite $35-a-barrel oil and steep natural-gas prices. Retail sales rose only 0.2 percent in August, and producer prices slipped 0.2 percent after a flat reading in July.

Then came the announcement that consumer prices fell - for the first time in 14 years - by 0.1 percent in August. A sharp drop in volatile energy costs swamped higher prices for clothes, prescription drugs, and other items. "Back to deflation," says Gerald Cohen, senior economist of Merrill Lynch, a major brokerage firm based in New York. And consumer spending, which accounts for two-thirds of national output, is rising at a moderate 3.5 percent rate this quarter.

All this means the Fed's "next move will be down," says Susan Hickok, chief economist at Prudential Economics in Newark, N.J. "[Short-term rates] must decline in coming quarters if the economy is to maintain momentum." But Ms. Hickok doesn't foresee a change in long-term rates - those that affect 30-year home mortgages - because they already reflect market expectations of a slower economy.

From the horse's mouth?

Even one Fed policymaker hints that a change in direction on interest rates might be in the offing. "Once we get over the energy hump, I wouldn't be surprised if inflation declines and interest rates are going to come down," Robert McTeer, president of the Federal Reserve Bank of Dallas, told The Wall Street Journal last week.

For more than a year, investors have watched with trepidation whenever Federal Reserve policymakers met, concerned that another boost in interest rates would clobber the stock market.

But the mood on Wall Street is now dramatically changed.

As evidence of this shift, both Hickok and Mr. Blood cite federal funds futures - a financial investment betting on the course of short-term interest rates in the future. Though unknown to most people, these futures contracts reflect views held by financial sophisticates. These views foresee a 6.5 percent interest rate in January 2001, significantly lower than the 7.3 percent rate foreseen as recently as May.

Still, some economists expect the economy to bounce back and the Fed to raise rates again. Among them, Ken Goldstein of the Conference Board, a New York research group, says: "There is enough momentum behind the economy that the Fed will have to jump in." Economists, he says, have been anticipating a slowdown for four years, but it has not materialized. He says the Fed may have to raise interest rates a few times before it gets the slowdown it wants.

The current consensus among economists is that growth in gross domestic product, the national output of goods and services, has slowed enough so that jobs will now not be quite as easy to get. "Workers will feel a little less secure," says Hickok.

Signs of a slower economy?

Wall Street, meanwhile, worries that a slower economy will bring more-modest growth in corporate earnings. Commentators often say the market tumbles because of that concern.

Some economists are already seeing evidence of a slowdown.

High interest rates have slowed construction, and high prices on imported oil may be prompting consumers to cut back on other purchases.

Moreover, although stock prices have been going up and down, they remain close to where they were at the start of the year, meaning investors may feel more restrained in their spending habits.

One flaw in the argument for raising rates, however, is that weekly wages after inflation remain 0.2 percent below the level of a year ago. That's "one reason why the Fed may lower rates," says Charles McMillion, a Washington consulting economist.

(c) Copyright 2000. The Christian Science Publishing Society

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