Tags: Debate: | Will | Fed | Keep | Raising | Rates?

Debate: Will Fed Keep Raising Rates?

Saturday, 15 April 2006 12:00 AM

But now, the yield on the 10-year Treasury bond is at 5% - higher than the official Fed funds rate of 4.75%. This was the first time in almost four years that the 10-year note floated above 5% - the highest it has been since the Fed started its tightening cycle.

Investors are speculating that the Fed will continue to raise rates when it meets in May - a quarter-point hike would bring short-term rates to 5%.

Though investors had pointed to the inverted yield curve as a sign of recession, it's become pretty clear that the economy's health is strengthening.

However, rising interest rates can have a deleterious effect on an economy - especially one that has been driven by a housing boom. According to the Washington Post, fully 75% of all job growth in the past five years is linked to the real estate boom.

When rates rise, it becomes more expensive to borrow money to finance the purchase of a home. We've already seen a drop-off in housing sales, and we've heard anecdotal evidence of home prices dropping. If the housing market stagnates, job losses may occur in droves.

In addition, it becomes more expensive to borrow against your home. And that's what has been driving the strong consumer demand in recent years. As housing prices skyrocketed, homeowners cashed out their equity and went on shopping sprees, buying cars, furniture, stocks - you name it.

As the equity on their homes dries up - and borrowing costs rise - it just makes sense that homeowners will stop spending the way they have been.

The Fed, of course, is trying to strike a balance between growth and recession. But they're often wrong. They either tighten too far or create bubbles with a loose monetary policy.

MoneyNews told you the other day how Greenspan ignored his chief forecast analyst when he warned the Fed chief about a possible recession. Greenspan hiked rates, only to lower them months later when the bubble popped on the Nasdaq and the economy slipped into recession.

The question is - will the Fed put the final knife into the housing bubble? And will this cause a recession?

Recent positive economic news - including major job gains - and analysis of the Fed's March statement have led the markets to the conclusion that continued rate rises are imminent.

"With short-term rates now close to normal levels, the economy near full capacity and inflation stable, the Fed and the markets believe the Fed can soon pause. But deciding when to do it and how to communicate about it are proving very tricky," according to The Wall Street Journal.

Some Fed officials believes a pause in hikes is coming.

According to the paper, Fed Governor Donald Kohn said in a speech that he didn't believe many more rate hikes would be necessary. "He predicted that growth would slow to a 'sustainable' rate after a strong first quarter, and that underlying inflation would remain 'roughly stable.' "

Another governor, Susan Bies, "told reporters: 'We are getting closer to the stopping point.' "

Meanwhile, any pause in rate rises would be based on a forecast 2% rate growth slowdown to 3% later this year - which would be enough to keep a lid on unemployment and allow business operations to continue working near capacity, without driving up wages and prices.

"Jan Hatzius, a Goldman Sachs economist, argued in a recent report that the Fed will be particularly careful to avoid over tightening because of its failure in 2000 to see how rapidly the economy slowed after the tech stock and spending bubble burst," says the WSJ.

Hatzius claims the Fed will stop at 5%, while other experts see no end in sight.

Only time will tell.

Two key economic indices rose in March, signaling an even stronger economy.

A burgeoning jobs market has sent Americans back into the malls and shops, as March retail sales numbers beat analyst expectations to rise 0.6% for the month. Concurrently, the University of Michigan's consumer sentiment index rose to 89.2, also beating analysts' expectations of an 88.9 level for the month of March.

It's mostly good news for the U.S. economy.

The data shows that consumers are buying more big-ticket items, like cars and big appliances, and are dipping their toes back into the home-improvement market as their confidence in the future of the U.S. economy grows.

Americans are buying more cars, furniture and building materials as wages and confidence increase, giving the economy greater momentum. The number of people collecting unemployment benefits fell to a five-year low, the Labor Department reported today.

"This economy is about as good as it gets," Federal Reserve Governor Susan Bies told a Los Angeles in a speech on Wednesday. "Employment is growing robustly. We're in a good position."

Individual retailers also fared well for the period.

According to a report from Bloomberg News on Thursday, Circuit City Stores Inc., the second-largest U.S. electronics retailer, announced that revenue rose 13% last quarter, beating analyst estimates. 3M Co., maker of Scotch tape and insulation for outdoor wear, also posted solid gains, announcing last week that first-quarter profit beat company expectations.

"Economists expected March sales to rise 0.4% after a 1.4% decline reported earlier for February, according to the median of 67 forecasts in a Bloomberg News survey," said the Bloomberg article. "Excluding autos, sales were forecast to rise 0.5%."

The only potential downbeat note: The upward trends in incomes and spending will likely influence the Federal Reserve to raise interest rates at its next meeting on May 10, 2006.

Dallas Fed President Richard Fisher said this week that "we're still enjoying healthy growth in consumer demand" and added there's no sign of a slowdown.

With the Easter holiday upon us, U.S. stock markets are closed this morning, giving analysts a short week to ponder before trading picks up again on Monday.

For the week, stocks finished up as investors saw positive numbers coming out of quarterly earnings reports. That offset some concerns over higher interest rates and elevated energy prices, as the Dow finished up plus 0.2%.

Still, as Charles Kirk points out in his trading blog TheKirkReport.com, both the Nasdaq (-0.6%) and the S&P 500 (-.05%) were down for the week.

"Strength in technology today suggests that buyers still have a buy-the-dip mentality," writes Kirk. "Trading volume was again well below average, and those looking for forward indications have noted that we've recently seen the disturbing pattern of strong volume on down days and weak volume on up days."

That should tee things up for an interesting post-Easter trading week.

"I would have personally liked to have seen more consolidation and weakness headed into earnings season," adds Kirk. "The herd's current perception is that earnings will be good and the second-quarter outlooks will be strong. I have no doubt that will be true for a number of stocks in very strong sectors. But, I also know that a lot of good news has already been priced in, with a few exceptions."


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But now, the yield on the 10-year Treasury bond is at 5% - higher than the official Fed funds rate of 4.75%. This was the first time in almost four years that the 10-year note floated above 5% - the highest it has been since the Fed started its tightening cycle. Investors...
Saturday, 15 April 2006 12:00 AM
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