2/3 of Bond Dealers See Fed Rate Cut in 2007 - Reuters

A stronger-than-expected employment report for December failed to dent expectations the next Federal Reserve policy move would be an interest rate cut this year, a Reuters poll of Wall Street economists showed on Friday.

All 21 primary dealers in the poll expect the central bank to keep benchmark interest rates steady at the Fed's next monetary policy meeting on January 30-31. But 14 out of 21 said they see the central bank reducing interest rates this year as core inflation moderates and a U.S. housing slowdown impinges on economic growth.

Of the 14 dealers expecting a rate cut in 2007, 8 predicted that the Fed would ease rates in the second quarter, while 5 said the Fed would cut in March. And Morgan Stanley believed the Fed would reduce rates in the fourth quarter.

Primary dealers are banks and securities brokers designated by the Fed to deal with it in trading U.S. government securities.

The generally robust non-farm payrolls report did change the forecast of two dealers -- Banc of America and CIBC World Markets -- which pushed back the timing of a rate cut to the second quarter of 2007 from the first.

"Although we continue to expect the next move in rates to be down rather than up, as housing headwinds intensify and core inflation eases, the Fed will want to see signs of greater weakness in the labor market, particularly a higher unemployment rate, before it steps off the sidelines," said Peter Buchanan, senior economist at CIBC World Markets in Toronto.

"Our amended view that the Fed will wait until the second quarter before starting to ease looks all the more probable after today's (non-farm payrolls) release," he added.

Bear Stearns, on the other hand, provided the most aggressive forecast, predicting a quarter-point percentage increase in the fed funds rate in May following Friday's jobs report. Four other institutions -- Barclays Capital, Daiwa Securities, J.P. Morgan Chase, and RBS Greenwich -- believed the Fed will raise interest rates in the fourth quarter.

Data on Friday showed that the U.S. economy added 167,000 new jobs in December, much higher than the expected 100,000 jobs that Wall Street had forecast.

But details of the report suggested that wage inflation remained on the high side. Average hourly earnings on a year-over-year seasonally adjusted basis rose 4.2% in both November and December. Those were highest gains for any 12-month period since a matching 4.2% in February 2001.

The December unemployment rate, meanwhile, held steady at 4.5%, well below the "full employment" rate that many economists assumed to be near 5.0%. Low unemployment
indicated persistent labor market tightness.

Some analysts noted the Fed would only start cutting rates once the unemployment rate begins edging toward 5%.

Interest rate futures implied chances of a Fed cut by March fell to 8% from 20% just before the employment report. Futures are fully priced for the Fed to hold rates steady at 5.25% at its January meeting.

Futures contracts for delivery later in 2007 posted losses, slashing prospects for a rate cut by June to 20% from 54%.

The Reuters poll also showed that two banks -- Credit Suisse and Lehman Brothers -- expected no change in interest rates for 2007.

Michael Gregory, a senior economist at BMO Capital Markets in Toronto, said that with unemployment rate a "tenth above its cyclical low" and wages rising, the Fed could be on hold for a while longer."

The Fed has kept rates unchanged since June at 5.25%, after 17 consecutive rate rises.