The debate over rates -- part II

[notiCIas]

The debate over rates -- part II

Bill Gross says the Fed is set to shift gears and may start cutting. Should investors bet with him?

June 22, 2005: 11:36 AM EDT
By Parija Bhatnagar, CNN/Money staff writer


NEW YORK (CNN/Money) - More and more investors seem to be buying into the idea that the Federal Reserve may soon be done with its interest rate hikes, and that the central bank may even cut short-term rates later this year.

But is Wall Street jumping the gun? Or is influential bond investor Bill Gross indeed out in front of the pack with his forecast that Fed policy-makers, led by chairman Alan Greenspan, may be getting set to end their year-old rate-hiking campaign?

Gross, chief investment officer of PIMCO, which runs the world's biggest bond fund, told reporters at an investment conference Tuesday that he expects the Fed may let up on rate increases after short-term rates reach 3.5 percent, probably in August, up from 3 percent currently.

He said the Fed could actually start cutting rates later this year.

Some market observers are betting along with Gross.

"The worse the outlook for corporate profits the better it's becoming for investors who are beginning to sense that perhaps the central bank will not raise interest rates again," Khuram Chaudhry, European stock strategist with Merrill Lynch, told CNN/Money by telephone from London. "When liquidity is in poor supply, it's good for stocks versus other asset classes."

It certainly appears that investors are increasingly thinking along those lines. For instance, despite last week's gush in oil prices to record-high levels, Wall Street seemed undeterred and eked out gains for five consecutive days.

And when Ford (Research), the nation's No. 2 automaker, warns on profits and signals more job cuts, as it did Tuesday, that can be enough to make investors uneasy. But stocks opened higher, though they later traded mixed Wednesday morning.

Further, analysts said a recent string of some softer-than-expected readings on the economy -- which coincided with some indications of a slowing global economy -- also support the growing sentiment that the Fed may be ready to start easing off of rate hikes.

"We're finding that the data from the U.S. on industrial activity were pretty weak," Chaudhry said. "It's so-so on the consumer although housing activity is still holding up. When you look at Europe, Sweden and Hungary both cut interest rates this week."

And on Wednesday, minutes released from Bank of England's June 8-9 meeting revealed that two out of its nine monetary policy committee members voted for a quarter-point reduction.

"These three data points from Europe and Bill Gross' comments [Tuesday] do support speculation about the Federal Reserve rethinking its rates policy," Chaudhry said.

"Central banks don't rest at one rate for long," Gross said Tuesday, according to Reuters. "If only to impart a bid to the U.S. housing market, they (the Federal Reserve) may have to start cutting again as early as the end of the year."

In a bid to stave off inflation pressures, the Fed has raised its target for a key short-term rate two percentage points in the last year, bringing the benchmark federal funds rate that banks charge one another for overnight loans to 3 percent. That's still near historical lows but the highest that interest rates have been since September 2001.

In its last statement following the rate action, the central bank's policy-makers said they would probably keep raising rates at a "measured" pace, signaling more quarter-point hikes in coming months.

But if, as Gross predicts, the Fed stops at 3.5 percent and starts cutting by the end of the year, that would have a huge effect on investors around the world.

Just wishful thinking?
Richard Suttmeier, chief market strategist with Joseph Stevens, said he's more interested in playing the devil's advocate than the rate-cut guessing game.

"Bill Gross may have the most fixed-income assets on the planet but his ability to forecast what the Fed may or may not do is not very good," Suttmeier said.

"Energy prices are way too high to stop raising rates. It's the high energy costs that caused the hyper inflation of the early 1980s," he said. "I think the Fed knows this but is afraid to tighten too much."

Suttmeier thinks it's become a very difficult, if not an impossible, balancing act for the Fed to change gears on rates and still keep to its main mission of stimulating growth and keeping inflation at bay.

"The world is awash with dollars. That has created a speculative housing, currency and commodities market," he said. "If the Fed changes its stance on rates now, it will be an admission that the policy-makers don't understand what's going on. Investors have to be very careful about what they're going to do because everyone will become sellers."

Michael Niemira, chief economist and director of research with the International Council of Shopping Centers (ICSC), feels that if the Fed is ready to back off, "a pause in rate hikes is a more likely scenario rather than a rate cut."

"No doubt the financial markets are anticipating that something could change. Whether that happens this summer or later remains to be seen," Niemira said. "There are some broader negatives in the economy right now but the they will take a long time to work through. For now, we can still get decent growth in profits even as costs rise."

Fed policy-makers are scheduled to meet next week, and then again in early August. No doubt, investors will be paying close attention to the Fed's policy statement for signs about policy-makers' willingness to change gears on rates.