Fed Likes The View, Has No Reason To Tamper With Rates Despite Greenspan’s Chilling Comments Earlier In The Week

The Federal Reserve is chasing history by running in place.

With the U.S. economy growing at a moderate pace, and inflation in check, the U.S. central bank approaches its last meeting of 1996 on Tuesday with no reason to raise or lower interest rates - and no signs on the horizon suggesting a change will be needed in the early months of 1997.

“The Fed is basically quite happy with the course of economic growth,” said David Jones, chief economist at Aubrey G. Lanston & Co. in New York. “The slowing we’ve seen is the path to a soft landing. As long as it looks like we’re still on that path, the Fed can keep its policy unchanged.”

Moreover, a provocative question posed a week ago by Fed Chairman Alan Greenspan has muted some of the “exuberance” of investors in U.S. stocks, eliminating any market-driven need to raise rates - or to raise margin requirements on stock purchases - at Tuesday’s meeting of the policy-setting Federal Open Market Committee.

If the FOMC holds off through May, it will match the longest period without a change in interest rates in recent decades, the 17 months between Sept. 4, 1992 and Feb. 4, 1994, when federal funds, the rate banks charge each other for overnight loans, stood at 3.0 percent. The last Fed move was back on Jan. 31, when it cut the federal funds rate by a quarter point to 5.25 percent.

Barring an external shock, there’s no compelling reason to think the economy will veer from its current path of growth in the 2.0 percent range, after posting a sizzling 4.7 percent annual pace in the second quarter, analysts said.

Consumers remain optimistic. The University of Michigan’s preliminary consumer sentiment index for December released today was at its second-highest level in 10 years, falling only slightly to 98.9 from last month’s 99.2.

They’re expressing that optimism at the malls. U.S. retailers this week reported sales increases for the second week in a row. That followed a 0.3 percent rise in non-automotive retail sales for the month of November, according to the Commerce Department.

The good feelings translated to the financial markets today. The benchmark 30-year U.S. Treasury bond rose 3/4, pushing down its yield more than 5 basis points to 6.57 percent. Stocks seesawed. The Dow Jones Industrial closed up just over a point, at 6304.87, after falling as much as 52 points during the first hour of trading.

Over the past three months, mortgage rates have fallen by almost a percentage point, “and that could spark a rash of refinancings” that would put more money into the economy, said John Tuccillo, chief economist at the National Association of Realtors.

Even more important from the central bank’s point of view, inflation is all but absent. The first 11 months of this year, consumer prices excluding food and energy have risen just 2.7 percent, down from 3.0 percent in the first 11 months of 1995.

That doesn’t even count subtracting the 1.1 percentage points a congressional commission recently estimated the CPI overstates inflation. While FOMC members haven’t taken a position on the size of the overstatement, “it’s not news” that members believe the inflation statistic is too high, said Fed governor Lawrence Lindsey.

For November, the core CPI rate excluding food and energy - rose 0.2 percent. “Until we start seeing more 0.3 and 0.4 increases in the core CPI, I don’t think we’ll get a tightening of monetary policy,” predicted Sally Kleinman, an economist at Chase Securities Inc. in New York. “Good economic growth in the first half of the year wasn’t enough to cause the Fed to tighten policy,” she said.

Still, while investors may believe that intuitively, it hasn’t sunk in emotionally yet. Greenspan sent markets swooning when, coining a now-famous phrase, he asked, “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and protracted contractions as they have in Japan over the past decade?”

Within hours of that speech the yield on the benchmark 30-year Treasury bond soared to a 30-day high in Asian trading, while futures on the Standard & Poor’s 500 Index posted their biggest decline in five months.

“I think foreign investors thought any time a central bank head complains about the market he’s ready to tighten. That was the mistake they made,” said Lanston’s Jones. “He was just jawboning.”

Since then, some on Wall Street have speculated the Fed might stop short of raising rates to prick any speculative market bubble, and simply increase margin requirements - the amount investors must pay up front when borrowing to purchase stocks.

That, too, is unlikely to happen. The Fed hasn’t changed the requirement, now 50 percent, since 1974 - in part because the practical effect would be small. The big run-up in stocks over the past few years has been driven by mutual funds, which avoid margin requirements by paying cash for the securities they buy.