A few months ago, many feared the credit crunch would put an end to the financial system as we know it and knock the world into recession. But those fears have not been borne out. Indeed, it now looks as though it's the Federal Reserve's interest rate cuts that are nearing an end, while optimism that the dollar and stocks have hit bottom has increased.
We at Action Economics are forecasting a quarter-point cut in the Fed funds rate target by the Fed Open Market Commitee (FOMC) at its Apr. 29-30 policy meeting, to 2.0%—a view widely shared by the rest of the market. In fact, some now question whether the Fed will ease at all. Earlier this month, by contrast, debate was swirling over whether the central bank would cut rates by 50 or 75 basis points.
Indeed, in Apr. 28 trading, Fed funds futures reflected between 75% and 80% for a quarter-point rate cut at the Tuesday-Wednesday FOMC meeting, from slightly lower odds evidenced last week. The consensus has also shifted toward at least a pause in rate cuts at 2%, while we and many others suspect it could be the last.
Economy Not So Weak
Here's what has happened to dampen Fed-easing expectations: Commodity prices have failed to moderate, as per the Fed's forecast, and have instead surged. This has prompted a meteoric 40-basis-point rise in the yield on the 10-year note over the past two weeks, to 3.85%. Food and energy prices have soared, while the dollar has weakened further. The economy outside the housing sector is not as weak as many economists had feared.
Add to those factors a $168 billion fiscal-stimulus plan, 300 basis points of rate cuts already in the system, and indications that more rate cuts may not be the answer to financial-market ills, and it's no wonder that recent speeches from Fed officials have indicated more caution on monetary policy easings.
We still doubt that the Fed will go cold turkey on rate cuts, given the continuing financial market stress. The bias should remain toward weaker growth, but with a downgrade in rhetoric that opens the door for a policy pause.
In its press release after the two-day April meeting, the Fed can reiterate much of the Mar. 18 policy statement, but with perhaps a few tweaks to its key phrases: "Inflation has been elevated, and some indicators of inflation expectations have risen," "financial markets remain under considerable stress," and "the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters." As always, the market will be weighing those words carefully.