Fed to hold rates steady: economists

Business Times - 14 May 2008

Fed to hold rates steady: economists

Some expect a recovery in the US economy next year

By LYNETTE KHOO

(SINGAPORE) Against the double whammy of mounting inflationary pressures and slower economic growth, the Federal Reserve is expected to hold its key rates steady for the rest of this year, according to panelists at yesterday's Lunch with the Economists 2008.

This likely pause follows a series of rate cuts by the central bank since last September, which brought the federal funds rate, the key overnight rate at which banks lend money to one another, to 2 per cent in April.

'I think the Fed is going to maintain the current Fed funds rate at 2 per cent at least for now,' said Thomas Lam, UOB group vice-president and senior treasury economist for global markets. 'But it is going to be accommodative to other unconventional means' of stimulating the economy.

Mr Lam expects at least another 10 per cent decline in home prices, and hence, does not think that the credit market problems are over yet.

Barclays Capital senior regional economist Sailesh Jha was more bullish. He predicts that the Fed would hike rates in the first quarter of next year by 75 basis points as he expects the US economic outlook to brighten up.

'We expect growth to accelerate in the second half of this year by as much as 3 per cent,' he said. 'We do think that in terms of the impact from Wall Street to main street, that is sedated.'

As the current US economic problem stems largely from housing and financial sectors, it is more easily solved by liquidity injection and cutting of interest rates, as compared with the broader manufacturing sector downturn during the Nasdaq tech bubble-burst, economists noted.

Some are expecting a recovery in the US economy next year, since the US non-financial sector continues to lend support.

'For the liquidity crunch or credit crisis, we have probably passed the mid-point,' Jan Lambregts, Rabobank International's head of Asia research, said. 'Once we work through the worst of the housing crisis, the US economy is going to rebound.'

This, he predicts, will happen as soon as next year.

With the recent global destabilisation caused by the surge in food prices, food inflation also became a hot topic during the panel discussion.

The economists noted that while much of the rise in food prices may be a result of speculative trading, the fundamentals are still pointing to upside risks in the near-term. Central banks are also going to find currency tools no longer effective in coping with inflation.

As some central banks in Asia look to raising interest rates or removing liquidity from the system, the risk is, Mr Lam of UOB cautioned, that overly aggressive tightening can cause a plunge in asset prices and equities.

In terms of the impact on investment choices, Mr Jha of Barclays reckoned that investors would continue to long commodities at least for the next two quarters. 'People are still very light in holding commodity assets in their portfolios and so, there's more to come and that's going to push prices up on top of the fundamental picture.'

But Subir Gokarn, chief economist for Asia-Pacific at Standard & Poor's, did not think that the rise in commodity prices, particularly that of energy and base metals, is sustainable as speculation in commodities, which is sentiment-driven, may soon recede if sentiment flips, while upside is capped by intervention by central banks.

'Commodities in many aspects is going to be the next bubble,' he reckons.

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