A Full Point for Bernanke & Co.?
Amid turmoil in credit markets and signs that the U.S. economy is slipping into recession, Federal Reserve policymakers meet on Mar. 18 to make a fateful monetary policy decision, with market speculation swirling around whether the central bank will cut the fed funds rate target by 75 or 100 basis points. Here's what Wall Street economists said on Mar. 17 about what they think the Fed will do, as compiled by BW and S&P MarketScope staff:
Tobias Levkovich, chief U.S. equity strategist, Citigroup (C)
The credit crisis and its aftermath seem to have claimed its biggest victim [with] Bear Stearns (BSC) collapsing into the arms of JPMorgan Chase (JPM). The counterparty risk issue, which developed both rapidly and meaningfully, forced the New York Fed to come in and provide stability through JPMorgan. Yet we suspect that investors remain fearful that other weaker securities firms could follow this path, with extreme concern over financial institutions now. With the very strong likelihood of even more evidence of recessionary conditions and likely forthcoming declines in domestic industrial activity due to credit pressures, we expect earnings to fall year over year in coming quarters, but sell-side consensus numbers remain too optimistic.
Also, given recent currency appreciation and commodity price developments, some weakness out of Europe and Japan should be expected as well. Soaring commodity prices and international wage pressures as well as a depreciating currency arguably causing imported inflation have led many investors to assume that the Fed will be stymied by CPI [consumer price index] data, though domestic wage pressures could fade quickly alongside employment declines. Thus, Citi's economists predict the Fed will trim the fed funds rate by 100 basis points this week, following [the Mar. 16] discount rate cut.
The "Lender of Last Resort"
Michael Englund, chief economist, Action Economics
Financial market turmoil since Friday [Mar. 14] was exacerbated by Fed action over the weekend, and these developments are consuming the market's focus, despite some dynamic swings in much of the U.S. economic data released [Mar. 17]. The change in the lending facility to include nondepository primary dealers signals a widening of Friday's instability, as does the reduction in the discount rate.
We now expect a jumbo Fed easing this week to help ease the heightened degree of panic in the markets, which was likely only exacerbated by the very weak Empire State headline figure and the February drop in industrial production.
For the Fed, the focus has shifted form broad monetary policy considerations to the more immediate "lender of last resort" role for the central bank, and we assume that the Fed will do what it thinks is necessary to achieve market stability. Our assumption for now will be a 100-basis-point easing, though it's certainly hard to calibrate what would strike each FOMC member as necessary. Presumably the Fed will see futures pricing as a useful gauge, and these prices are dancing around expectations of just more than 100 basis points of easing.
Data Consistent with Recession Theme
John Ryding, chief U.S. economist, Bear Stearns
Even before the latest stresses of the financial markets hit, we think the economy had fallen into a technical recession, and these data remain consistent with this theme. With the velocity of events picking up markedly since the middle of last week, we expect the Fed to cut the funds rate by 100 basis points [on Mar. 18] (a call we adopted on Friday [Mar. 14]) in addition to the funding facility that was announced for primary dealers. Although the details of the New York Fed Empire State index report do not fully corroborate the weakness in the headline index, this report is consistent with our recession and inflation themes.
Although the weakness in industrial production was exaggerated by a sharp decline in utilities output, and although the decline in manufactured output was entirely due to a reduction in auto output, there are too many signs of weakness in manufacturing reports to dismiss the recession message given by industrial data.
Fed Working Creatively to Deal with Crisis
David Wyss, chief economist, Standard & Poor's (MHP)
The Federal Reserve moved dramatically over the weekend to shore up the financial system. The acquisition of Bear Stearns by JPMorgan had been rumored since last Friday; the surprise was the price of only $2 per share, much lower than expected, and the Fed guarantee of up to $30 billion. The Fed is treating Bear as if it were a large failed bank. It also lowered the discount rate 25 basis points, to 3.25%, only 25 basis above the [fed] funds rate. The discount window was opened up to primary dealers as well as banks, and loans were allowed to be extended for up to 90 days rather than the normal 30.
The Fed continues to be creative in trying to break the financial markets out of their freeze. A 100-basis-point rate cut now seems likely Tuesday [Mar. 18].
Odds Grow for a 100-Basis-Point Cut
Joseph LaVorgna, chief U.S. economist, and Carl Riccadonna, senior U.S. economist, Deutsche Bank (DB)
There has been no letup in financial market deterioration. The speed, breadth, and depth of the evolving credit crisis means that risks to the economy will remain distinctly to the downside, with a growing possibility that second-half growth prospects suffer meaningfully in lagged response to the current tightening in the credit markets. Importantly, inflation is not a concern for the Fed, nor should it be. Recessions cleanse inflation pressures out of the economy, and the growing possibility of a longer and deeper recession means that inflation could come down quite significantly at some point. We wrote last Friday [Mar. 14] that over the last five recessions, headline inflation, as measured by the CPI, declined by an average of two-thirds. Furthermore, February's extremely tame CPI report, which showed flat headline and core readings, should also remove some lingering inflation concerns among the more hawkish FOMC officials. Therefore, we believe the Fed will cut rates by 75 basis points tomorrow afternoon, and the odds of a 100-basis-point cut are growing. Whether the Fed opts for an unprecedented 100-basis-point move will depend largely on financial market conditions, namely whether the market further raises the probability of systemic solvency issues. Another day of price action like last Friday [Mar. 14] could tip the scale in favor of 100 basis points.