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Will the Fed Scramble to Tackle Recession?

Wednesday, 9 Jan 2008 | 2:35 PM ET

Despite the growing chorus on Wall Street predicting a recession this year, economists say the Federal Reserve is unlikely to cut interest rates before its regularly scheduled meeting later this month.

Even those economists who view the December spike in unemploymentas an ominous sign say that a rare intra-meeting rate cut is neither necessary nor appropriate.

Ben Bernanke
Ben Bernanke

“There’s a real bias against that, unless it is a real emergency,” says Bank of Tokyo-Mitsubishi-UFJ’s senior financial economist Christopher Rupkey, who says a recession is now a fait accompli.

“If they change policy it will spook the markets, saying things are so bad they can’t wait, “ adds Robert Brusca, chief economist at FAO Economics. “I don’t get the sense that there is support for that kind of cut right now.”

The last time the Fed made an intra-meeting rate cut was following the terrorist attacks of Sept. 11, 2001. Then-Chairman Alan Greenspan also made a surprise cut of half a point at the beginning of that year, on Jan. 3.

For all the recent criticism of the Fed’s handling of the economy, economist are quick to point out that the central bank has reacted to the slowdown by slashing a full percentage off the funds rate, which now stands at 4.25%.

The Fed’s decision to cut rates by only a quarter of percentage point at its December meeting surprised many observers. But there’s a growing consensus that the central bank will cut by half a percentage point at its two-day Jan. 30-31 meeting.

Fed watchers are likely to have a better idea after Chairman Ben Bernanke’s speech in Washington at 1 pm New York time Thursday, when he is expected to discuss the economy and the financial markets.

Bernanke's Speech Will Be Broadcast Live on CNBC.com on Thursday

“If you look at the economic landscape, there’s still no sense of collapse going on. “ says economist Ram Bhagavatula, managing director at Combinatorics Capital, who has been forecasting a recession for several months. “If consumer spending is holding up fairly well, then I don’t see why the Fed would want to cut rates aggressively.”

The same can’t be said for the labor market. One traditional recession indicator is a rise in the jobless rate of half a percentage point from its expansionary low. This time around it is 4.4 percent, which was reached last summer. The three-tenths of one percent jump in December’s rate to five percent clearly set off alarm bells.

Merrill Lynch’s North American economist David Rosenberg last Friday declared a recession was now in hand. In a note to clients Monday, Rosenberg said, “Friday's employment report confirmed our suspicions that the economy was transitioning into an official recession towards the end of last year.”

Goldman Sachs Wednesday echoed that. “The recent rise in unemployment is particularly worrisome,” wrote economist Jan Hatzius.

Wall Street economists are well aware that the Fed pays close attention to the jobless rate recession barometer and that it was a key consideration in setting policy going into the short and shallow 2001 recession.

David Resler, chief economists at Normura International, isn’t quite ready to jump on that bandwagon, saying a big jump in the jobless rate with a recession is rare but “not-unprecedented.” He does not see it as a “death knell for the economy.”

Resler is among those to conclude that GDP growth in the fourth quarter of 2007 will be stronger than originally expected – plus 2.0% -- largely because of consumer spending. Though he says first-quarter growth is “looking dicier”, he remains unconvinced that a recession is in the cards.

Some at the Fed appear to agree. As recently as Tuesday, St. Louis Federal Reserve Bank President William Poole said there is no clear evidence that a recession is at hand. The verdict is hardly out on inflation, which has been unusually sticky, with high energy costs still threatening to trickle down into the economy.

Economist expect Bernanke to signal his views to the markets in his Thursday speech, sponsored by Women in Housing and the Exchequer Club. Bhagavatula expects” a dovish stance.”

“Bernanke’s going to have to say something, if there’s been a material change in the economy,” adds Rupkey.

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