What the Fed Has to Consider at Tuesday's Meeting

Mon Sep 20, 2004
By Victoria Thieberger

NEW YORK (Reuters) - The Federal Reserve is set to nudge up borrowing costs on Tuesday for the third time this year, brushing off recent worries about the economy in its desire to restore interest rates to more normal levels.

Financial markets and Wall Street analysts have heeded a barrage of optimistic commentary from senior Fed officials, who argue the recent "soft patch" in the economy has passed.

A recent Reuters poll of 22 top economists on Wall Street found they unanimously expected an increase in the federal funds rate at Tuesday's meeting, to 1.75 percent from 1.5 percent.

The Fed's language could be a bit more upbeat on the economy than in its August statement, they say, and bond market hopes that officials may hint at a pause in tightening are likely to be disappointed since the Fed likes to keep its options open.

Central bankers want official rates to get closer to a "neutral" range that neither stimulates nor slows growth.

The Federal Open Market Committee, which sets monetary policy, will issue a statement after its meeting, at around 2:15 p.m. on Tuesday.

Here are a few of the factors the Fed will consider:

LUKEWARM JOBS GROWTH

Payrolls rose a moderate 144,000 in August, the first time the report has come in near expectations in months, yet even that lukewarm gain was hailed with relief after two much worse months. However, the increase is still far short of normal job growth three years into an economic recovery.

Oil prices are stuck above $40 a barrel. Fed Governor Edward Gramlich suggested last week the Fed would respond to any inflation impact from oil by continuing to raise rates, even if this produced "bumpier" economic growth and higher unemployment for a time.

Retail sales dropped 0.3 percent in August, with declines in auto sales, furniture and clothing. Still, overall consumption this quarter seems to have improved from the anemic 1.6 percent pace of the second quarter, a comparison some Fed officials have made.

The manufacturing sector seems solid, with factory production up 0.5 percent in August, although some regional surveys have pointed to slower growth in September.

Inflation has proved to be mild after all. Core measures rose by no more than 0.1 percent for three months in a row, suggesting no need for the Fed to speed up its pace of tightening.

TOO LOW FOR COMFORT

Numerous Fed officials in recent weeks have delivered a similar message: that the 1.5 percent federal funds rate is too low for a growing economy, despite recent mixed economic news, and needs to be restored to a more normal level. Gramlich called the current funds rate "inordinately low."

In testimony on Sept. 8, Fed Chairman Alan Greenspan said data suggested the economy has "regained some traction."

On Sept. 9, Janet Yellen, the San Francisco Fed president, said the hurdle for data is "reasonably high" for the Fed to pause in raising rates because the fed funds rate is so low.

DANCING TO A DIFFERENT TUNE

Treasury yields have continued their relentless downward march, with the market doubting the Fed's optimism. The 10-year yield slipped to 4.09 percent on Monday, down 20 basis points since the Fed's last meeting and counteracting higher official rates.

Fed funds futures, which bet on the path of interest rates, have fully priced in a hike on Tuesday and one more move by Christmas, either in November or December.