PETALING JAYA: All eyes and ears will now be on what the US Federal Reserve (Fed) will do or say at its upcoming meeting on Tuesday as turbulence roils the US stock markets.
Reeling from what has been described by Bear Stearns Co as the worst debt market in two decades, the decision facing the Fed would be whether to cut interest rates to bolster the economy at the expense of containing inflation, or to talk up the market.
Weak economic data, especially from last Friday's jobs report showing rising unemployment in the US, has increased the likelihood of an interest rate cut but there are different opinions on whether the Fed will listen to Wall Street.
“This turmoil is not enough to alter Fed policy,'' former Fed governor Laurence Meyer, who is now vice-chairman of St Louis-based Macroeconomic Advisers LLC, said in a Bloomberg report. He sees the Fed holding its targeted federal funds rate at 5.25% through to the end of 2008.
The report said the risk of not slashing rates might leave financial markets struggling and also hinder the economy's recovery to a growth of 3% or so, from a sub-par 2% pace in the first half.
It said housing in the US continued to slump, while consumer spending – until now the bulwark of the economy – was slowing. Auto sales in July were at their lowest in nine years while payroll growth slowed as unemployment increased.
“The chances of a recession have now risen to 45%,'' said former Fed governor Lyle Gramley, currently a senior economic adviser at the Stanford Group Co in Washington.
Fed officials had played down the danger to the economy of a decline in stocks during the last two weeks, and the tightening of borrowing conditions in the credit market.
The “fundamentals are really unchanged,” Fed Governor Randall Kroszner said in testimony before the Senate Banking Committee on Aug 2.
While tighter corporate credit may slow growth a bit, company balance sheets on the whole were in good shape, thanks to surging profits, Fed officials said in the report.
A separate report by Reuters quoting analysts said the Fed would welcome a rise in unemployment.
That, in theory, was a sign that some slack was developing in a labour market that policymakers had previously considered tight enough to present an inflation risk, would now suggest that the slowdown in non-food, non-energy inflation was sustainable, the report added.
“From its lowest point in May, the three-month average unemployment rate is now up 12 basis points, close to what triggered Fed easing in the past (about 16 bps) and about one-third of what has typically signalled the onset of recession,” the report quoted a research note by economists at Goldman Sachs.