Investors like the idea of another interest rate cut by the Federal Reserve. The Fed probably will deliver on Wednesday.
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But Michael Moskow, the recently retired president of the Federal Reserve Bank of Chicago, says don’t get used to it.
Moskow, who participated in 104 meetings of the Federal Reserve’s monetary policy committee during his 13 years as head of the Chicago Fed, described the central bank’s dilemma in a speech to the fall investment conference of Altair Advisers, a Chicago-based investment advisory firm.
“If they do nothing and conditions deteriorate, they will have to play catch-up,” Moskow said. Since it takes six months to a year for Fed rate actions to ripple through the economy, playing catch-up as the economy slides toward recession is not a good idea, he said.
On the other hand, “if they cut [Wednesday], investors will expect more cuts and build it into their forecasts,” he said.
Given the current state of the economy and inflation, creating expectations of more easy money would be as counterproductive as failing to act.
“They have to be prepared to retract that cut pretty quickly if they find that conditions improve more rapidly than they expect,” Moskow said.
It’s not unusual for the Fed to telegraph explicitly its intentions when it issues its periodic statements after monetary policy committee meetings. As the Fed raised interest rates repeatedly in 2003 and 2004, the statement said on each occasion that the central bank intended to remove easy-money conditions at a “measured pace.”
One possible precedent for Wednesday’s scheduled statement goes back nearly nine years, to November 1998. At that time the Fed cut its short-term rate target to 4.75 percent from 5 percent in October and 5.25 percent in September.
The successive rate cuts came after the last major crisis in financial markets, sparked by a bond default by Russia and the collapse of the Long Term Capital Management hedge fund. Like today, the federal government became involved in rescuing financial firms from the wrong-way bets by financial wizards.
But the November 1998 statement said that after three quarter-point cuts, “financial conditions can reasonably be expected to be consistent with fostering sustained economy expansion while keeping inflationary pressures subdued.”
That remark signaled the end of rate cuts. The Fed’s next move was to increase interest rates to 5 percent in June 1999. In magnitude, the rate cuts in the fall of 1998 are similar to what the Fed is expected to achieve with Wednesday’s expected cut.
Moskow said the statement accompanying Wednesday’s action will be read closely. He predicted that “language will make it clear that this isn’t just a series of cuts and make it clear they’re not promising more cuts in the future.”
The former Chicago Fed chief, who recently joined the board of credit card vendor Discover Financial Services, said his preview of Wednesday’s Fed meeting was not based on discussions with former colleagues at the Chicago Fed or the Federal Reserve in Washington.
Public data certain to be reviewed Wednesday by Fed officials contain “no evidence” that the housing recession has spilled over to retard consumer spending generally, Moskow said. The pace of monthly employment, including Friday’s expected report of an 80,000 gain in jobs this month, is still “a pretty good rate,” he said.
The trend in consumer spending is worrisome, and could weaken along with house prices, if consumers feel less wealthy, he said. But business spending “seems to be OK so far.”
Finally, the inflation outlook “is better than in early August,” the last time Moskow attended a Fed rate policy meeting.
Two risks faced by his former colleagues are the chance that the current stress in high-risk credit markets will persist and contaminate other markets and the economy.
Also, Moskow worries about a “low probability” event, a sudden steep and rapid decline in the value of the dollar in foreign exchange markets.
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