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Likelihood of Fed Rate Cut Less Clear       Send a link to a friend

[September 08, 2007]  NEW YORK (AP) -- The arrival of September was supposed to bring more clarity to the economic impact of the current credit crisis. Instead, each new bit of data coming out seems to be creating more confusion.

The first labor market contraction in four years, as revealed Friday in a weaker-than-expected jobs report, shows that the housing and mortgage collapse is putting some strain on the economy. And the continued dislocation in commercial paper markets, where companies raise cash to fund their operations, should be taken as a warning sign _ in flashing red _ that more bad news may be coming.

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Yet plenty of good economic news still stands out. Strong August sales results from retailers and manufacturers suggest the painful credit crunch's effect on the broader U.S. economy has been limited so far.

Anyone hoping that Federal Reserve policymakers will reduce the overnight bank borrowing rate when they meet on Sept. 18, should not ignore the positive signs the economy is giving.

Given what we know now, a Fed rate cut is no sure bet; Fed Chairman Ben Bernanke has said he would only lower short-term interest rates if the economy needed a stimulus.

He's not in the rate-cutting business to save financial markets from turmoil, like the volatility we've seen in the last month amid increasing evidence of tightening credit conditions. That knocked stocks down from record highs in a punishing decline.

He also won't use lower rates to bail out hedge funds or mortgage lenders who find themselves facing tough times as credit conditions tightened in recent months.

Plenty of CEOs from companies most troubled by the credit and housing mess _ including the top brass at Countrywide Financial Corp. and Hovnanian Enterprises Inc. _ have done their best in recent weeks to paint as grim a picture as possible about the overall economy. They keep saying a recession will come if the Fed doesn't act.

But Bernanke and his team of central bankers can't rely on such self-interested views to direct monetary policy. They'll be spending the next week or so mulling over as much current data as they can to help them determine how the Fed should proceed.

Right now, the key overnight lending rate, known as the federal funds rate, stands at 5.25 percent. It has been there since last summer after 17 quarter-point rate increases from 2004 to 2006 to keep inflation in check as the economy expanded rapidly.

Financial markets have been rooting for a rate cut soon _ some investors even hope that the Fed knocks off as much as half a percentage point _ to help ease credit conditions. Lower rates would reduce borrowing costs for everyone from potential homeowners to companies looking to finance activities and purchases.

But the Fed won't make a move unless it feels it must. Current data won't make its decision any easier.

The Fed's Beige Book, which describes anecdotal economic conditions in regions around the country, showed that "weakness in the housing market deepened." And four of the 12 districts _ Philadelphia, Richmond, Dallas and San Francisco _ reported that the pace of economic expansion had slowed.

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But the report, released on Wednesday, also noted that there has been little spillover from the financial market volatility into the overall economy. The report's first sentence said that the economy "continued to expand."

"It certainly does not rise to the sort of anecdotal deterioration that would require an immediate monetary policy response," noted Goldman Sachs' economics team in a report to clients.

Consumers, in the meantime, seem undeterred by the financial turmoil, given that the latest retail sales figures shows that they went on a back-to-school buying spree last month. Another new report, from the Institute for Supply Management, showed that the credit markets' troubles did little in August to thwart modest expansion in the manufacturing sector.

At the same time, however, other data points released in recent days are more suggestive of deceleration, said Goldman Sachs.

The National Association of Realtors reported Wednesday that its pending home sales index tumbled 12.2 percent in July, the biggest drop on record. And that was even before the credit market tightening seen last month, which Goldman's economists say makes the July decline more significant because it will likely mean an even larger drop will come when the August numbers are reported.

The labor market also appears to be weakening. Employers sliced payrolls by 4,000 jobs in August, the first decline since 2003. That data from the Labor Department on Friday was far worse than economists' estimates of payrolls growing by 110,000 last month.

Such indicators, and others the general public doesn't get to see, are at least out there for the Fed to digest. The potentially big losses in the mortgage securities markets that have yet to be revealed could be more worrisome. They could trigger a broader financial crisis that delivers a more potent shock to the economy.

With hedge funds and mortgage lenders rooting for a rate cut, it's difficult for many investors to see the positive side to the economy. If the Fed's central bankers don't ease rates, their view likely is that the economy seems to be holding up.


Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck@ap.org

[Associated Press; By RACHEL BECK]

Copyright 2007 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.


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