NEW YORK (CNNfn) - The Federal Reserve is widely expected to cut interest rates for the seventh time this year at the end of its policy meeting Tuesday, but economists are divided about what the central bank's next move will be.|
Most economists expect the Fed to cut its target for the federal funds rate, an overnight bank lending rate, a quarter percentage point to 3.50 percent.
"I think they'll cut a quarter point, like everybody else in the market," said Maureen Allyn, chief economist at Scudder Kemper Investments. "The markets have gotten a pretty good read on what's going on, and I take my cue from them."
But recent reports of falling prices, continuing strength in the housing market, a possible recovery in the labor market and stabilization in manufacturing have painted a more optimistic picture of the economy's health, leading some observers to wonder if the Fed's work is done.
"Realistically, they've done a lot already. The economy may be sleepy, but you don't need to hit it with everything you've got," Allyn said.
A hint of the Fed's plans will be found in the statement accompanying its decision. So far this year, it consistently has said the risks to the economy were weighted more toward slow growth than toward inflation, meaning it was willing to cut rates again, if necessary.
"They'll still see the risk as toward weakness," said Scott Brown, senior economist at Raymond James & Associates. Brown also thinks the Fed will cut a quarter point Tuesday, but it will be a "compromise move."
"The Fed is very much split at this point. That's no big secret," Brown said. "Some Fed officials think they've been pretty generous, while others are more worried about the global economic slowdown, capital spending and corporate profit margins."
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The Fed has cut rates six times this year, from 6.5 percent to 3.75 percent, in an effort to keep consumers spending and keep the U.S. economy out of a recession.
Historically, rate cuts have taken 12 to 18 months to begin to have an impact on the economy, meaning it's possible that none of the Fed's actions this year have had any impact on the economy yet.
In addition to the interest-rate cuts, Americans only now are beginning to spend their advance payments of 2001 tax credit, commonly called "rebates," part of Congress' recently passed tax bill, which many economists think will boost economic growth in the second half of 2001.
With all these stimuli in the system, some economists wonder if another rate cut after Tuesday would be too much, even though the government reported Thursday that consumer prices posted their biggest drop in 15 years in July, meaning inflation is well contained.
"I don't think we can discount the legitimate concern that the Fed has been pumping too much liquidity into the economy," said Bill Cheney, chief economist with John Hancock Financial Services. "It may be that they have to backpedal furiously as the economy starts to recover. Inflation has been down for so long, it may be hard to imagine it ever getting back up -- but you better believe it still can."
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It's difficult to believe, but the last time the Fed was worried about inflation was only a year ago, when it was in the middle of a series of rate hikes intended to put the brakes on what it thought was a runaway economy.
As rates rose to nine-year highs, companies cut back on spending on new technology and other capital improvements. At the same time, energy prices rose sharply and the speculative bubble of technology stocks on the Nasdaq rudely burst, sending individual wealth plummeting.
Consumers, who drive two-thirds of the U.S. economy, stopped spending as businesses trimmed hundreds of thousands of jobs in response to anemic demand. To boost consumer confidence, the Fed spent the year slashing interest rates to their lowest levels since April 1994.
The economy so far has avoided a recession, defined as two consecutive quarters of shrinking gross domestic product (GDP) growth. Economists think second-quarter GDP could be revised downward and into negative territory, especially after a report Wednesday showed inventories and sales at U.S. businesses falling and another report Friday showed the U.S. trade deficit with other nations widening.
But the National Bureau of Economic Research (NBER), which usually is one of the first groups to recognize a recession, said Aug. 3 it hadn't seen enough negative data yet to justify even discussing whether or not a recession had started.
Still, the potential for weakness hasn't gone away, and the implied yield on the federal funds futures contract for November, after the Fed's next policy meeting, scheduled for Oct. 2, is at 3.27 percent, compared with the current Fed funds rate of 3.75 percent, meaning the bond market is betting on another rate cut.
According to an Aug. 16 Reuters poll, 25 "primary dealers" -- investment banks that trade directly with the Fed in fixed-income markets -- unanimously agreed the Fed would cut rates Tuesday by a quarter percentage point, but only 12 of 25 expected another quarter-point rate cut by the end of the year.
As for the stock market, it's certainly expecting at least a quarter-point cut Tuesday, so it likely won't respond much if the Fed makes such a cut.
"The stock market reaction, if they cut a quarter point, probably will be as much a yawn as anything else," said David Blitzer, chief investment strategist at Standard & Poor's. "If the Fed would go for half a point, which is within the realm of possibility, I think it would get a positive reaction."
But such a boost would be short-lived. What the market really needs to make lasting gains is confidence about the future health of the economy and, subsequently, corporate earnings.
"We're in for another year of slow movement [in the stock market]," Blitzer said. "It increasingly will have an upward bias, but it won't go through the roof."