One Case for a Fed Pause on Rates

This Thursday could be a wild one, traders say, a day when the market may fly or fry.The Federal Reserve’s Federal Open Market Committee on Thursday will wrap up a two-day meeting to determine the best course for short-term interest rates. Given the renewed inflation fears, most pros expect the Fed to raise the fed funds rate another 25 basis points, to 5.25%, its 17th consecutive boost since June 2004. Some, in fact, think a 50 basis point increase is even possible.“We’re in for a torturous Thursday if we get another increase, not that it will shock anybody because everybody expects it,” asset manager Miki Berkhardt, one of the West Coast’s most skilled day traders, says. “But the risk is it will just re-enforce the likelihood of another increase in August at a time when everyone is hoping for a pause.”Mr. Berkhardt expects a 25-point increase Thursday, which he figures will push stock prices lower. If it’s a 50-point hike, he says, “you’re looking at about a 200-point drop in the Dow.”Suppose he’s wrong and the Fed pauses? “I think you’ll see the Dow rise 200 to 250 points,” he says. “But you should ignore pause talk, because that strictly comes from dreamers.”Oppenheimer & Co.’s chief investment strategist, Michael Metz, is no dreamer. Openly bucking the crowd, he forecasts “a definite pause Thursday,” arguing “the Fed has done its damage and is through raising rates for now.” The well-known Wall Street veteran attributes this to what he describes as “a significant deceleration of economic growth in America.” As for inflation – the market’s no. 1 worry – he doesn’t believe it’s a problem the Fed can control. The reason: brisk demand for commodities such as steel, copper, and oil from China, India and various developing countries.For some time, many economists and money managers had shared Mr. Metz’s outlook that there would be a pause this month. But heightened inflation worries, spurred by higher than expected core inflation numbers the past two months and stepped-up hawkish comments from various Fed governors, have led most to rethink the situation and predict a Thursday hike.What’s more, some pros think that boost will likely be followed by another two or perhaps three increases, to 5.75% to 6%, given, in particular, high oil prices and a probable rebound in commodity prices. A noted former Salomon Brothers economist, Henry Kaufman, during an interview the other day on Bloomberg Television predicted a 6% fed funds rate before year’s end.To Mr. Metz, the real problem the market faces is not inflation but that the economy is slowing very dramatically. His outlook calls for just 2.5% GDP growth in the current quarter and a 2% annual rate in the second half. Further, he expects more economic fatigue in 2007, with the year showing GDP growth of only about 2%. In contrast, most believe next year will produce GDP growth of 3% or more, an outlook Mr. Metz describes as “much too optimistic.”Where, he asks, is the great stimulus for the economy? He sees none, other than exports, which he believes is at least two years away. “The consumption boom is over,” he contends. What’s more, housing is definitely slowing, which means people will extract less from their homes for consumption purposes. Likewise, he notes, job creation is slowing, further tax cuts are not likely, and any more excess federal spending is out because of the $500 billion budget deficit.Mr. Metz’s scenario for a sharply slowing economy also factors in his belief that the much talked about capital spending boom will not materialize. Yet another deterrent: a rise in the savings rate.This economic sluggishness, Mr. Metz points out, also adds up to slowing earnings growth. For example, he sees at most an 8% to 9% advance for the second half, not Wall Street’s expected 10% to 12% growth. For all of 2007, he projects earnings will grow 5% to 7%, maybe less, as compared to the widely predicted Street increases of 10% to 12%.What does it all mean to investors? “We’re in a blah market for the next year or so,” Mr. Metz says, with the Dow, for example, confined to a trading range of 10,000 to 12,000. The Dow closed Friday at 10,989.If he’s right about a Fed pause, wouldn’t that trigger a rally? Mr. Metz agrees, but he figures it would be brief and unsustainable because of a slowing economy.In a provocative Fed-related forecast, investment adviser Stephen Leeb of Leeb Capital Management says the new Fed skipper, Benjamin Bernanke, is on borrowed time. “He won’t last; I give him 12 months, tops” Mr. Leeb says. His big quarrel with the Fed chief: “He’s transparent when he should be opaque.” In other words, he should keep his thinking to himself.dandordan@aol.com

One Case for a Fed Pause on Rates

One Case for a Fed Pause on Rates

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