The turning of the tide
The Federal Reserve begins nudging interest rates upward
'It's not a gimme putt." That's how Alan Greenspan, an admitted duffer on the golf course, described to a Senate committee what should be his final mission as chairman of the Federal Reserve Board: a carefully calibrated series of interest rate hikes over the next year or two intended to cool the economy just enough to stave off inflation. The Fed initiated the rate-tightening cycle last week with a quarter-point hike of the federal funds rate, which banks charge each other on overnight loans.
It's a delicate balancing act but one many think Greenspan can pull off. Along with predecessor Paul Volcker, the chairman, whose fifth and final term will come to a close in January 2006, is likely to go down as one of the two most important Fed chiefs. Greenspan got a helping hand late last week with news that job growth in June had slowed significantly from its torrid pace earlier in the year. Some 112,000 new jobs were created, less than half the number economists had expected, leaving the unemployment rate steady at 5.6 percent. While bad news for the unemployed, it's good news for Greenspan & Co. if it gives them the flexibility to raise interest rates at their desired "measured" pace. If he pulls off his latest ploy, Greenspan, having already piloted the economy through three wars, two recessions, two stock market crashes, and an Asian financial crisis, "will be declared a man who walks on water unfrozen," says Paul McCulley, a Fed expert at bond fund giant Pimco.
Most economists and investors are optimistic that the Federal Reserve and its larger-than-life chairman are up to the task, but there are no guarantees. In fact, more than a few notable economists say the central bank may already be playing catch-up with rising prices. "Their analysis of inflation has been too optimistic for some time now," says Roger Kubarych, an inflation hawk and senior economic adviser at HVB America, a subsidiary of German bank HVB Group. He points to the personal consumption expenditures deflator, the Fed's preferred inflation barometer, which rose in May at an annual rate of 6 percent, as well as the median price for existing homes, which is 10.3 percent higher than a year ago.
Oil slick. The policy statement accompanying the Fed's rate hike mentioned the elevated inflation data but discounted it as the result of special factors, namely a sharp spike in the price of oil.
On the other hand, there are signs that the economy is actually losing a bit of its steam. The growth rate for the first quarter was recently revised downward, to an annualized 3.9 percent from 4.4 percent, after the Commerce Department factored in a larger-than-expected trade deficit. Factory orders fell in May for the second straight month, led by declining auto sales. Consumer spending, the economy's biggest engine, may be slowing, too, according to many retailers. Both Wal-Mart and Target warned last week that June sales will be weaker than previously expected. And the job-creation machine hiccuped last month. Though the service sector added jobs, especially in healthcare and business services, manufacturing lost 11,000 jobs in June after several months of small increases. The slowdown in employment gains surprised the markets, though an increase in initial claims for state unemployment benefits in recent weeks might have been a harbinger.
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