Federal Reserve policy makers signaled they are in no hurry to reduce interest rates again because they aren’t convinced the U.S. economic expansion is coming to an end.
The Federal Open Market Committee avoided foreshadowing its next move after lowering the benchmark rate on Sept. 18, minutes of the meeting, published yesterday, showed. Officials didn’t want investors to conclude extra cuts were guaranteed, the records said.
Economic reports since then have justified their caution: manufacturing and services industries continued to expand last month, while employment picked up. The Dow Jones Industrial Average has climbed 3 percent to a record since the meeting.
“I don’t think the Fed will move in October, but I certainly don’t think they’ve ruled it out,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. For now, “the economic data have not made much of a case for any additional easing.”
Fed staff economists cut their estimate for fourth-quarter growth, the minutes said, while stopping short of predicting a recession. Three Fed bank presidents today and yesterday said credit market conditions have improved, yet remain fragile. Fed officials next meet Oct. 30-31.
“They can now afford to take their time, and gather more data,” said Charles Lieberman, chief investment officer at Advisors Capital Management LLC in Paramus, New Jersey, and a former economist at the Fed’s New York branch. “Certainly, the sense of urgency is gone.”
Mortgages, Risk
The gap in interest rates between 30-year fixed-rate mortgages of $417,000 or less and 30-year “jumbo” loans of more than that amount fell to 78 basis points in the first week of October. That’s down from 98 basis points last month, according to Bankrate.com. A year ago, the difference was 31 basis points, or 0.31 percentage point.
A Citigroup Global Markets index tracking risk spreads of sovereign bonds and other credit securities has dropped to 0.77 from 0.91 the day before to last month’s Fed meeting. A reading of 1 indicates high risk aversion.
“There is not as much of the edginess of concern with the short-term funding markets,” said James Caron, global head of interest-rate strategy at Morgan Stanley in New York. “There is still room for an accident going forward.”
Janet Yellen, president of the San Francisco Fed, said yesterday that liquidity constraints “are gradually being resolved,” although markets aren’t back to “business as usual.” She made the comments at a speech in Los Angeles.
`Still Fragile’
St. Louis Fed chief William Poole said in a speech in his bank’s home town that financial markets have stabilized, yet “have not returned to normal and are still fragile.”
Boston Fed President Eric Rosengren, in his first speech since taking office in July, said while “investors are not reassessing risk in a wholesale way,” it will likely take “some time” for them to become more confident about assessing some types of securities.
Policy makers all concluded it was best to lower their benchmark rate by half a point to 4.75 percent, double the amount that most economists forecast, the minutes showed.
Yields on federal funds futures contracts show a 64 percent probability that Fed officials will leave the benchmark lending rate unchanged at this month’s meeting.
Risks to Economy
“Further actions would depend on how economic prospects were affected by evolving market developments and by other factors,” according to the records. Any statement on the balance of risks to the economy “could give the mistaken impression that the committee was more certain about the economic outlook than was in fact the case.”
Fed officials continued to express concern about inflation, citing labor costs and a weaker dollar, the minutes showed. The currency fell to a record low of $1.4283 per euro on Oct. 1.
“Inflation risks could be heightened if the dollar were to continue to depreciate significantly,” the minutes said.
The Fed’s preferred price gauge, which excludes food and energy costs, rose 1.8 percent in August from a year earlier, the third straight month within the 1 percent to 2 percent comfort range stated by several officials. Policy makers “were a little more confident” the decline “would be sustained,” the minutes showed.
Job Growth
The FOMC expressed some skepticism about Labor Department figures that showed the first decline in U.S. payrolls in four years. The August report was later revised to show a gain of 89,000 jobs, from the previous estimate of a 4,000 decline. Employers hired 110,000 in September.
“If no big shoe drops in the meantime, I think they will hold steady” on Oct. 31, said former Dallas Fed president Robert McTeer. “I think if they don’t cut at the next meeting, they are through.”
Housing “remained exceptionally weak,” the minutes said, and “the faster pace of foreclosures as subprime mortgage rates reset was also seen as posing a downside risk” to residential real estate.
The Fed staff “marked down” their fourth-quarter economic growth forecast, and “trimmed” the 2008 outlook, the minutes said, without providing details.
“We do not know how financial markets will evolve, and we do not know how households and businesses will respond to financial developments,” Fed Vice Chairman Donald Kohn said in a speech in Philadelphia last week. “We will need to be nimble in adjusting policy to promote growth and price stability.”
To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net .
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Posted by bondsblog as FED Watch at 8:05 AM EDT
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Federal Reserve Bank of Philadelphia President Charles Plosser said last week’s interest-rate cut could cause inflation to accelerate and that policy makers must be ready to reverse course if needed.
“Cutting the funds rate has the potential for aggravating inflation, there’s no question about that,” Plosser told the New Jersey Technology Council late yesterday. Should inflation or price expectations rise in coming months, “the outlook will be affected and policy may have to be adjusted.”
Plosser, who doesn’t vote on rates this year, is the first official to express concern about the Fed’s Sept. 18 decision to lower the benchmark interest rate by a greater-than-forecast half-point. The reduction, while “appropriate” because of slowing job growth and falling home prices, shouldn’t lead to further moves unless data become “much weaker,” he said.
“I will not be surprised to see weaker statistics,” Plosser said in the speech in Mount Laurel, New Jersey. “But weaker numbers will not lead me to revise my outlook or my view of the appropriate funds rate target unless they are much weaker than already anticipated and accumulate sufficiently to generate another downward revision in my outlook.”
The Federal Open Market Committee unanimously voted to reduce the rate on overnight loans between banks to 4.75 percent, the first cut in four years, aiming to keep financial-market turmoil from ending the U.S. economy’s six-year expansion.
Traders expect the Fed to lower the rate a quarter-point at each of the next two FOMC meetings, on Oct. 30-31 and Dec. 11, based on futures prices.
`Appropriate’ Move
“A slower economy means that real interest rates must decline to bring about the appropriate adjustments to restore growth,” Plosser said. “In recognition of this, I believe last week’s action to lower the fed funds rate target was appropriate.”
Economic reports yesterday bolstered the case for the Fed to keep cutting rates. Consumer confidence slumped to the lowest level in almost two years, a Conference Board index showed. The National Association of Realtors said August sales of previously owned homes dropped to the weakest pace in five years.
Two-year Treasury note yields declined 2 basis points to 3.97 percent as of 7:49 a.m. in London. Against the euro, the dollar traded at $1.4128 in London and reached $1.4162, the lowest since the European currency’s debut in January 1999.
Plosser’s remarks contrast with comments by other Fed officials since the Sept. 18 decision. Chairman Ben S. Bernanke and Vice Chairman Donald Kohn didn’t mention risks from the rate cut in remarks last week.
Asset Prices
Bernanke told lawmakers the move was designed to “try to get out ahead of the situation, try to forestall potential effects of tighter credit conditions” on the economy. Kohn said in Frankfurt that the central bank was motivated by the potential for asset-price shifts to affect growth and inflation.
Plosser, whose anti-inflation remarks have been among the Fed’s toughest since he joined the central bank last year, had expressed skepticism about the economic risks from financial turmoil 10 days before the Fed meeting. While the surprise loss of U.S. jobs in August was “not encouraging,” it didn’t on its own justify lowering rates, Plosser said Sept. 8 in Hawaii.
The Labor Department said Sept. 7 that employers cut 4,000 workers in August, the first drop in four years.
Yesterday, Plosser said the June and July job-growth figures, which were revised lower, were “more troubling” and suggest the labor market “may not be quite as tight or as robust as we previously thought.”
Rebound in Growth
At the same time, “there is also the possibility that growth will rebound more quickly than is now anticipated,” he said. “If so, and the outlook is revised upward, monetary policy makers will have to reassess” policy, he said.
Plosser, who votes on rates for the first time in 2008, emphasized that “price stability is and should be the primary focus of monetary policy.” Officials “must resist the temptation to respond to short-term, transitory disturbances” unless they affect the Fed’s long-term goals, he said.
Plosser, 59, is a former professor and business-school dean at the University of Rochester who took the helm of the Philadelphia Fed bank in August 2006. He was previously co- chairman of the Shadow Open Market Committee, a group of economists that critiques Fed policy and has traditionally favored keeping inflation close to zero.
The risks from the rate cut underscore the need to have a public, numerical inflation goal, a topic debated by Fed officials for the past year, Plosser said. It’s not the exact target for inflation, that matters, he said, but the idea that the Fed has a stated “commitment.”
Separately in yesterday’s speech, Plosser said the economy can expand at about 2.75 percent annually over the next few years without stoking inflation. He estimated longer-term productivity growth at “slightly below 2 percent.”
To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net ; Anthony Massucci in Mount Laurel at amassucc@bloomberg.net .
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Posted by bondsblog as FED Watch at 7:58 AM EDT
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Central banks may not have the tools to restore stability to credit markets amid the “Panic of ‘07,” and instead should demand greater transparency from financial companies, Moody’s Investors Service said today.
Derivatives and the growth of hedge funds using unprecedented amounts of debt have magnified the impact of a rise in borrowing costs, New York-based Moody’s said in a report.
“The new financial paradigm has brought with it some problems, which the world’s financial policy technicians have not yet solved,” Moody’s said in a report by Vice Chairman Christopher Mahoney and Senior Vice President Pierre Cailleteau. “Each credit crisis teaches new lessons, often resulting in corrective reforms. The current `Panic of ‘07′ will as well.”
Central banks failed in their initial efforts last month to stem a credit crunch that was sparked by rising defaults on subprime mortgages. The banks used their traditional instruments for propping up markets such as adding cash to the financial system through overnight lending and cutting interest rates.
The cost of overnight borrowing in pounds rose yesterday by the most since June as the bailout of U.K. lender Northern Rock Plc stoked concern that more home-loan providers will be forced to seek emergency funding. The Bank of England yesterday made 4.4 billion pounds ($8.8 billion) of emergency loans to U.K. banks and the U.S. Federal Reserve cut its benchmark interest rate by half a percentage point to 4.75 percent to prevent the economy from sinking into recession.
Halts, Closings
At least 110 mortgage companies have halted operations or sold themselves since the start of 2006, including American Home Mortgage Investment Corp., the Melville, New York-based lender. Countrywide Financial Corp., the biggest U.S. mortgage company, was forced to tap bank credit lines after being shut out of the short-term debt market and banks provided $21.4 billion to shore up GMAC LLC, the lender owned by General Motors Corp. and Cerberus Management LP. Hedge funds, including two run by Bear Stearns Cos., collapsed and Newcastle, England-based Northern Rock sought its bailout last week.
Foreclosures set a record in the second quarter and overdue payments on U.S. subprime mortgages rose to the highest level in five years, according to the Mortgage Bankers Association.
`No Idea’
Moody’s itself, as well as Standard & Poor’s and Fitch Ratings, were criticized by investors, lawmakers and regulators for being too slow to respond to the rising defaults. The ratings companies are being probed by the U.S. Securities and Exchange Commission and policy makers including European Central Bank President Jean-Claude Trichet have pointed to possible conflicts of interest between the ratings companies and the banks that pay their fees.
Moody’s, S&P and Fitch waited until April to downgrade some subprime securities, after their value had fallen by as much as 80 cents on the dollar. Analysts have been updating ratings “as fast as we can,” Mahoney said.
Investors have an “over-reliance on ratings for pricing,” he said. Some “have no idea what they have and they have no idea how to price it.”
The global financial system, Moody’s said, has evolved from a “sleepy” world dominated by banks and fixed exchange to one in which capital flows across borders and is allocated by the market, not financial institutions.
Confidence Undermined
“It has become clear that not knowing where the risk is can undermine confidence in the stability of counterparty credit,” Tim Frost, a portfolio manager at London-based hedge fund Cairn Capital, said in an interview yesterday. “The palpable loss of confidence in the market recently will reinforce to management and regulators that firms need to `fess up’ when they have losses.”
A $1.6 billion debt fund run by Cairn was last month bailed out by Barclays Plc, the U.K.’s third-biggest bank, after it was unable to raise money in the credit markets.
Traditionally, the Fed’s control over banks has enabled it to ease any credit crunch by adding money to the financial system, Moody’s said. The Fed has almost no control over the hedge funds that are among the biggest investors now, Moody’s said.
Mortgage Bonds
“The intensity of the impact of a financial shock on the economy will depend on the central banks’ ability to restore `fluidity’ throughout the system,” Mahoney and Cailleteau said in the second of a series of reports addressing the crisis. “We expect market and official pressure to require greater transparency from financial actors.”
In the previous report on Sept. 5, Mahoney and Cailleteau said the adjustment in prices of mortgage bonds tied to borrowers with poor credit will last at least six more months.
“We expect some pressure on capital ratios” for banks, Mahoney said during a conference call today. “We don’t expect any major banks to breach capital ratios, but it will be bearish for credit creation during the period banks digest this unwanted meal.”
The next report from Moody’s will study the role of credit rating companies in the market, Mahoney said in an interview.
The “deficiencies exposed” by the present turmoil are mostly the same as when Greenwich, Connecticut-based hedge fund Long-Term Capital Management LP collapsed after Russia defaulted in 1998, Mahoney and Cailleteau wrote.
Rebundled Risks
“The greater the loss of confidence, the harder it is to restore and crucially the greater the erosion of confidence, the greater the contagion and the broader the financial safety net may have to be spread,” the analysts said. “This is the ultimate conundrum of the philosophy of market discipline.”
Moody’s last month said a hedge fund collapse on the same scale as LTCM was possible. Investment banks are facing larger losses than when LTCM had to be bailed out after wrong-way bets on global bond prices, Standard & Poor’s said last month.
“Risks have been unbundled and rebundled into tradable instruments,” the Moody’s report said. “The new financial world created by securitization had not been subjected to a stress test of this magnitude until now.”
Derivatives are financial instruments derived from bonds, loans, stocks, currencies and commodities, or linked to specific events like changes in the weather or interest rates.
“What turned an overdue risk reappraisal into a financial panic is the combination of untested financial innovation, price- sensitive accounting rules, leverage and opacity,” Mahoney and Cailleteau said. “This cocktail has proved explosive.”
To view the original article, click here.
To contact the reporters on this story: Mark Pittman in New York at mpittman@bloomberg.net ; Kabir Chibber in London at kchibber@bloomberg.net
Posted by bondsblog as FED Watch at 7:56 AM EDT
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