Business Awaits Fed's Rate Decision

FUTUREVISION would like to be stringing cable-television systems in its home state of Mississippi. But, interest rates are too high to make it profitable.

"We have to think very carefully about any kind of expansion, with these rates," says Bobby Chain, president of the Hattiesburg-based electrical contractor.

Mr. Chain is not alone in wishing for lower interest rates. Everyone from Wall Street investors to home buyers wants to see rates fall. Federal Reserve policymakers will meet tomorrow to decide whether to make entrepreneurs like Chain happy or continue on the same course.

Some economists believe the Fed needs to act soon. "If we don't get a reduction in rates in the next three to four months, we will be risking a recession, three or four quarters out," says Gary Shoesmith, director of the Center for Economic and Banking Studies at Wake Forest University in Winston-Salem, N.C.

If the Fed does not lower rates tomorrow, there is a widespread expectation it will move in January. "There is a feeling of inevitability that rates will drop," says William Sullivan, a senior vice president at Dean Witter Reynolds in New York

In the financial markets, for example, short-term interest rates have fallen sharply. If the central bank were to follow the lead of the market, short term interest rates would drop a full percentage point.

The stock market is feeding off the optimism of the bond market, Last week the Dow Jones industrial average crested the 5,200 mark before falling back to close at 5,176.73.

"It is a fairly unusual set of circumstances for the market to be driving rates down while it appears the Fed is trying to hold them up" (to fend off inflation), says Charles Plosser, dean of business administration at the University of Rochester, N.Y.

Some economists are concerned about the market's assumption on the direction of interest rates. "The bond market is now highly speculative," warns Lyle Gramley, a consulting economist for the Mortgage Bankers Association and a former Fed board member.

Mr. Gramley says the financial markets are beginning to resemble late 1993, when the financial markets were convinced the Fed would not raise rates. When the Fed did hike rates, the stock market plunged. "We are seeing the same kind of stuff right now," he cautions.

Gramley, in fact, holds that any rate cut is unwarranted. The economy, as measured by the gross domestic product, grew at close to a 4.5 percent annual rate in the third quarter and is expected to grow at a 3 percent rate in the fourth quarter. With signs that the economy is still plowing ahead, Gramley says, "If I were a member of the Fed, I would pound the table with no uncertainty and say the easing of monetary policy would be a terrible mistake."

The Fed's decision comes against a background of falling interest rates last week in Europe. Central banks from London to Frankfurt dropped rates in an attempt to stimulate sluggish European economies. "The economy there is soft and getting softer," says C. Michael Aho, an international economist with Prudential Securities in New York.

Although the US economy is currently steaming ahead, there are signs it may be running out of fuel. On Friday, Dun & Bradstreet released a survey of the bellwether construction industry that predicts a sharp slowdown in their industry in the next three months. Behind the pessimism is a drop in orders to the lowest level in three years.

In economic news last week, the government reported industrial production edged up 0.2 percent in November and capacity utilization fell to 83.1 percent.

At the same time, inflation numbers were mixed. Last Thursday, the government reported the consumer price index was unchanged in November. Earlier in the week, the government said the November producer price index rose by 0.5 percent, higher than expected.

Merrill Lynch economist Bruce Steinberg calls the PPI report "fluky" since it was unduly influenced by increases in car prices. Although he does not think the PPI report precludes Fed action tomorrow, he says "it does make the odds less favorable."

While economists debate the nuances of policy, businessmen just wish the climate would permit a rate reduction. Futurevision borrows funds at about one percentage point over the prime interest rate of 8-3/4 percent. "That adds up to a lot of money in a period of years," Chains says.

Two years ago when he was borrowing money at 7 to 8 percent, Chains had 200 workers laying cable. "We were very aggressive. We could still be doing the same thing but I would not try it with the rates we are living with today," he says.

In Atlanta, home-builder Rick Porter, president of Richport Properties, says high borrowing costs to finance his operations are squeezing his profits.

One result, says Mr. Porter, is that his company is more careful about which amenities are standard and which are options. "We tend to option more and more of the big-ticket items like sun rooms and lofts," he explains. "You have a better margin on the add-ons."

Despite the squeeze on his margins, Porter says he is glad to see inflation in check. With high inflation, he notes, long-term interest rates rise. Then fewer people can afford mortgages. "If I had to choose, I'd take lower long rates and let me struggle with my margins," he says.

of 5 stories this month > Get unlimited stories
You've read 5 of 5 free stories

Only $1 for your first month.

Get unlimited Monitor journalism.