Steady On at the Fed
Greenspan raises rates again despite Katrina's impact
Short-timers are supposed to just keep their heads down and run out the clock. But Alan Greenspan isn't following the script. Even though the 79-year-old Federal Reserve chairman has only four months left as the nation's central banker, he is playing the role of inflation hawk to the end. No better evidence of this than the decision last week by the Federal Open Market Committee to hike the rate banks charge each other for overnight loans by a quarter percentage point to 3.75 percent. That's the 11th-straight increase and the highest level since June 2001.
Although this further credit tightening was hardly a surprise to Wall Street, there had been chatter that the Fed might take a breather--or even stop altogether--because of the deficit-busting impact of Hurricane Katrina. Not only have energy prices spiked, but the number of people filing for unemployment benefits surged last week to the highest level since mid-2003 as Katrina's effects rippled through the economy. And the Gulf Coast disaster seems to have taken a big chunk out of consumer confidence. The University of Michigan's index of consumer sentiment fell to 76.9 for September, down from 89.1 in August. It is now at its lowest level in a decade.
But it's clear from the Fed's brief statement that it's betting any damaging economic fallout from Katrina will be short term rather than a "persistent threat" to an economy still supported by "robust" productivity growth. "What this is saying is that nothing the Fed has seen has changed its view, and they have decided to keep plowing ahead," says James Swanson, chief investment officer at MFS Investment Management. There was one dissenting vote, the first time Greenspan has not had complete unanimity since 2003. The uttering of the all-too-familiar phrase "policy accommodation can be removed at a pace that is likely to be measured" suggests that more rate hikes are in the offing.
"I am surprised the Fed did not at least moderate the language," says Robert MacIntosh, chief economist at Eaton Vance and a bond fund manager. Perhaps Greenspan & Co. are watching the surge in gold prices. The yellow metal is often purchased as a hedge against inflation and is now above $470 an ounce, a level not seen since the late 1980s. How much higher might short-term rates go? Plenty of Fed watchers are predicting they'll rise at least another quarter to half percentage point. Economist Ed Yardeni, chief investment strategist at Oak Associates, tells clients the Fed would prefer to boost short rates as high as possible--perhaps up to 5 percent--without sending the economy veering toward recession. The Fed governors "want to make sure they have plenty of room to ease next time they have to do so," Yardeni says. Now, 5 percent might seem pretty painful compared with 1 percent, where the fed funds rate was back in June 2003. But the higher level should not necessarily sound the death knell for the current economic expansion, which admittedly is a little long in the tooth. Rates were between 5 and 6 percent during the high-octane period of the late 1990s.
THE GREENSPAN EFFECT
The Fed has adjusted the rate that banks charge one another for loans 24 times since January 2001.
1/3/01 6 pct.
6/25/03 1 pct.
9/19/05 3.75 pct.
[chart labels] 0,2,4,6 pct.
Source: Federal Reserve Bank of New York
USN&WR
This story appears in the October 3, 2005 print edition of U.S. News & World Report.
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