Posted on 05/10/2004 1:41:14 PM PDT by RWR8189
NEW YORK, May 10 (Reuters) - It is rare for economists on Wall Street to agree on anything but for once they are united, sharing the view that the Federal Reserve will raise interest rates in June, or August at the latest.
But they still differ on how far the U.S. central bank will go, now that the economy is on a sure footing and inflation is on the rise.
A blockbuster April U.S. payrolls report has prompted a wholesale shift in thinking about the Fed on Wall Street and analysts now see no reason for it to put off lifting official interest rates from rock-bottom levels.
They do disagree, though, on how much tightening is in store this year, since the federal funds rate is starting off at an ultra-low 1.0 percent.
Estimates range from a modest 1.5 percent target for the fed funds rate at the end of the year to 2.25 percent, according to a Reuters poll taken after Friday's jobs report.
"There is a much higher hurdle for the first move than there would be for all subsequent moves," said Stephen Stanley, chief economist at RBS Greenwich Capital, who is at the top end of the range at 2.25 percent by year-end.
Indeed, the Fed for six months used words like "patience" on policy and keeping rates low for "a considerable period" to dampen market expectations about the first rate rise.
That language vanished from the Fed's policy statement last week, opening the door to the first rate hike since May 2000. Instead, the Fed said it will be "measured" in raising rates.
MEMORIES OF 1994
Fears of rising official rates hit stocks hard on Monday, with the broad S&P 500 index closing down 1.05 percent at 1,087.12.
Policymakers have been waiting for evidence the U.S. recovery is sustainable, and a surge of 625,000 new jobs created in March and April has dispelled such doubts. The Reuters poll found all 19 economists surveyed now predict a rate rise in June or August.
"Once they start to go, you can presume that means they've seen sufficient evidence the economy is strengthening that they know the accommodative policy is no longer appropriate," said Stanley, of RBS Greenwich Capital.
Investors are starting to worry about rising inflation, in contrast to last year's concern that falling prices or deflation could set in.
Futures markets are pricing in a fed funds rate around 2.0 percent by the end of this year, rising to close to 4.0 percent at the end of 2005, according to eurodollar contracts.
Indeed, with the first rate rise seen as a done deal in coming months, markets seem to be better prepared than during the last major tightening cycle of 1994.
Memories of 1994 still haunt bond traders because the central bank hiked rates unexpectedly and triggered widespread losses, contributing to the demise of Wall Street firm Kidder Peabody and the bankruptcy of California's Orange County.
This time, futures contracts anticipate an entire series of rate increases.
"The word 'measured' is a not-so-subtle hint that it will not be 1994 all over again and yet the market has already made up its mind, taking the completely opposite bet," said Merrill Lynch chief economist David Rosenberg.
He pointed to previous tightening cycles in 1987, 1994 and 1999 when investors consistently underestimated the total amount of Fed rate increases.
"The market, it seems to us, is moving to price in the classic overshoot even before the Fed's first volley, which frankly is something we've never seen before, at least not to the same extent. We have never seen an entire tightening cycle priced in before the actual onset of the cycle."
The camp on Wall Street that had been expecting the Federal Reserve to stay on hold this year capitulated en masse on Friday, with one of the leading advocates Goldman Sachs saying its position was "untenable".
But this group still tends to see more modest tightening overall. Dresdner expects only two rate rises this year, in August and September, taking the fed funds rate to 1.50 percent.
"Inflation will remain well contained and they are just taking back the insurance easing they put in place for deflation fears" last year, Dresdner economist Elizabeth Denison said.
Really? Says who?
Wow! Rutters admits the economy is on sure footing! The sky is falling, run for your lives! Hell has frozen over!
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