Investors Put Bets On a Fed Rate Cut

By Neil Irwin
Washington Post Staff Writer
Tuesday, October 30, 2007

Six weeks ago the Federal Reserve cut interest rates, a move that calmed panicked credit markets and sent stock markets soaring. Now investors faced with more troubling data are betting that the Fed will reduce rates again tomorrow.

Since the Fed's action, major financial institutions have had difficulty understanding the scope of their losses from the recent credit crunch, and economic data have been discouraging. The Fed's announcement is just one of several major pieces of economic news this week that will give the clearest sense yet of how badly the economy has been hurt.

Tomorrow morning, the government will announce how much the economy grew in the third quarter. Economists are worried that the housing market and credit problems of the past three months will lead consumers to spend less, slowing the economy. The third-quarter data will be an indicator of whether that has begun to happen.

On Friday, the Labor Department will release unemployment and job-growth statistics that will show whether companies were hiring in October.

Traders who make bets on the federal funds rate, which the Fed uses to manage the economy, have in the past two weeks become convinced that another rate cut is likely. The traders yesterday afternoon said there was a 74 percent chance that the Fed's policymaking committee would cut that rate by a quarter of a percentage point, to 4.5 percent.

The Fed's actions will indicate how seriously it views the threat to growth -- a rate cut would stimulate the economy by making it cheaper for consumers and businesses to borrow money. When the Federal Open Market Committee, the Fed's policymaking group, announces its interest rate policy tomorrow afternoon, it will also issue a statement that will be scrutinized by economists trying to determine whether the Fed is inclined to cut rates further at the next meeting of the Federal Open Market Committee, on Dec. 11.

"They don't want to give a signal that they're done cutting rates, nor that we clearly have more coming." said Peter Hooper, chief economist of Deutsche Bank Securities. "They want to leave open the options as widely as possible."

The gross domestic product and jobs numbers will give economists more details on how the economy has been doing recently. The GDP is the broadest measure of the nation's economic health. The third-quarter data capture how much U.S. output grew from July through September. Economists surveyed by Bloomberg News expect a 3.1 percent annual growth rate.

That would be a strong reading. But it is not terribly useful for understanding what the housing downturn and credit market crisis mean for the future of the economy, according to economists, who will be looking to somewhat more obscure indicators in the thick report.

One of those is inventories. If there's a rise in the ratio of business inventory to sales, it could be a sign that the corporate sector will be inclined to pull back on production in the coming months to clear out the excess. That would be a drag on future economic growth.

Consumer spending is the largest component of GDP, and analysts will be looking to see if Americans spent less as the quarter progressed. Further detail about income and spending patterns in September will come out Thursday morning, as well.

The employment report Friday will give evidence of whether the labor market is holding up despite the problems in the housing and credit markets. Economists widely believe that continued job growth is the key to avoiding a significant downturn in the economy; consumers' houses may become less valuable, the logic goes, but so long as they have jobs, they'll keep spending.

"There are times in the business cycle when the labor market is not that important," said Jan Hatzius, chief economist at Goldman Sachs. "But right now it is of peak importance."

The consensus of economists surveyed by Bloomberg News is that employers added 80,000 jobs in October and that the unemployment rate held steady at 4.7 percent. While that would not be a particularly strong rate of job creation, it might allay fear that the labor market has slowed sharply. The number of initial claims for unemployment insurance has ticked up in recent weeks, worrying economists.

An indicator worth watching in that report is "duration of unemployment," or how long unemployed people have been looking for work. When that measure rises, it is often early evidence of a softening job market, even if the total unemployment rate is unchanged.

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