Giving The People What They Want

U.S. financial markets threw a new temper tantrum on Monday but private-sector economists suggested that the Federal Reserve was going to give them what they want: much lower interest rates.

Stocks extended their slide and investors scuttled for the perceived safe-haven of Treasury bonds. The U.S. central bank is all but certain to make the fixed-income market unattractive by slashing rates now and worrying about inflation later.

Mickey Levy, chief economist at Bank of America, continues to expect the Fed will ease 50 basis points on March 18, taking the federal funds rate down to 2.5% from the current 3.0%. In a report published on Sunday, Levy added that the risks of a larger 75-basis point cut have increased because of the February employment report, and another week of deteriorating credit conditions.

"In our view," Levy wrote, "the implication of a prolonged period of soft economic growth is that the Fed will maintain its accommodative policy until well into 2009, with projected tightening to begin midyear."

Economists at Goldman Sachs also expect a 50-basis-point cut to be announced on March 18, but noted that after Friday's ugly payroll report, one cannot rule out a more aggressive response. The economists also speculated that a cut could come before the meeting, but noted that the likelihood of such a move will drop as the meeting approaches.

On Monday afternoon, Joseph LaVorgna, chief U.S. economist at Deutsche Bank, said he is now targeting 1.5% fed funds by midyear. "The ongoing deterioration in financial market conditions is broadening and gaining speed," LaVorgna said, "this means the Fed is going to have to cut rates further in order to prevent an even deeper recession that what we are currently forecasting."

LaVorgna also believes the Fed will cut rates by 75 basis points at the upcoming meeting, and keep the door open for more cuts after that. "The Fed will not take the chace of disappointing skittish financial markets by only 50 basis points," LaVorgna said. He continued, saying that he expects the Fed to cut 50 basis points at the April 30 meeting and then another 25 basis points at the June 25 meeting.

LaVorgna doesn't think the Fed will stop at 1.50% either. "Even at 1.50% fed funds, we cannot say this is the absolute low. It depends entirely on the financial markets and how they wind up impacting the real economy. Hence, we would view 1.50% as a soft floor," LaVorgna said. He added that if it appears the US. economy is slipping toward recession later this year, after the tax rebates wear off, the Fed could cut its target on federal funds, which is what banks charge each other for overnight loans, as low as 1.0% by the end of the year.

The bond market exploded as investors fled from equities, dropping Treasury yields. The 10-year note was yielding 3.44%, down from 3.56% Friday and 3.54% a week ago, and fed funds futures were indicating expectations for aggressive easing of the Federal Reserve's monetary policy. (See: "The Fed's Fix")

The dollar remained under pressure, falling to 101.80 yen from 102.84 on Friday. The euro was stable near its record high, at $1.5342, down a bit from $1.5347.

The Fed has been cutting interest rates since September to counteract weakness in the U.S. economy, much of which is emanating from a crisis in the housing market. That crisis was kindled by low interest rates, enacted by the central bank in the wake of the bursting of a stock-market bubble in 2000 and the terrorist attacks of Sept. 11 the following year. The Fed took rates down from 6.5% in 2000 to 1.0% in 2003, reviving the stock market, but leading to a bubble in housing prices that was exacerbated by imprudent lending. By the summer of 2006, fed funds were back up to 5.25%, but the subsequent housing collapse and virtual freezing of the world's credit markets forced the central bankers to reverse course once again.

The latest rate-cut predictions came in the wake of a bevy of economic news, much of it bad. (See: "U.S. Economy Runs With Tortoises") On Friday, the Fed said it would increase the size of its two term auctions of short-term funding to banks this month to $100 billion from the $60 billion previously announced. It also would start a series of term repurchase transactions with the primary dealers that trade securities directly with the Fed, expected to be worth a total of $100 billion. (See: "Fed: The Bank That Keeps On Giving")

The Fed announced its move minutes before the Labor Department said the February employment picture in the United States was far worse than had been expected, with 63,000 jobs lost. Expectations had been for a modest gain. (See: "Jobs Plunge Worst In Five Years")