Fed Rate Cut Skepticism Spreads From Bank Presidents (Update1)

By Scott Lanman and Steve Matthews

Oct. 4 (Bloomberg) -- Federal Reserve district bank presidents are expressing skepticism about the need for further interest-rate cuts, and some investors agree.

The chance of policy makers cutting their benchmark rate twice more this year, to 4.25 percent, fell to 48 percent today, the lowest since the Fed cut borrowing costs on Sept. 18, futures prices show. The December contracts last week reflected a 74 percent likelihood of two quarter-point reductions.

Sentiment shifted as St. Louis Fed Bank President William Poole, Philadelphia Fed chief Charles Plosser, Atlanta's Dennis Lockhart and Richard Fisher of Dallas in the past 10 days highlighted signs the turmoil in credit markets is easing. Economic and financial reports have complemented their remarks, as commercial paper halted a seven-week slump and surveys showed continued expansion of manufacturing and services industries.

``I give them a lot of weight,'' said Keith Hembre, who helps oversee $110 billion as chief economist at FAF Advisors in Minneapolis, referring to the comments by the bank presidents. ``I don't think the evidence is clear that the Fed needs to take additional action.''

Hembre, a former Minneapolis Fed economist, expects the rate-setting Federal Open Market Committee to keep borrowing costs unchanged unless indicators ``substantially'' worsen.

``The credit markets are more stable than they were during August,'' Fisher said today after a speech in Charlotte, North Carolina. ``Things are healing.''

Federal funds futures traded on the Chicago Board of Trade were little changed after a Commerce Department report showed factory orders dropped more than forecast in August.

No Contradictions

Unlike their similar comments before the Sept. 18 Federal Open Market Committee meeting, this time the presidents' views haven't been countered by other policy makers. Fed Governor Frederic Mishkin, who last month detailed a rising risk to consumer spending, refrained from such a remark today in a Frankfurt speech. Vice Chairman Donald Kohn speaks on the economy tomorrow.

Views of policy makers and investors may still change before the Oct. 30-31 meeting. The Labor Department reports on September payrolls tomorrow and a surprise second month of declines could stoke expectations for more rate cuts.

Members of the Board of Governors in Washington and the New York Fed chief hold permanent seats on the FOMC. The other 11 presidents rotate among four voting positions. All participate in the discussions.

Countering Assumptions

Stocks fell on Sept. 28 after Poole said it would be wrong for ``markets to bake into the cake the assumption of ongoing rate cuts.'' Plosser and Dallas Fed President Richard Fisher both even broached the possibility of raising rates to keep inflation in check. ``Should further correction'' in rates be needed in either direction, ``we will make it,'' Fisher said Sept. 24.

The remarks cemented the officials' stance in analysts' eyes as ``hawkish,'' or more inclined to keep rates higher to contain inflation. Richmond Fed President Jeffrey Lacker, dissented four times in 2006 in favor of raising rates.

``I don't think another move in October is a done deal,'' said former Fed governor Lyle Gramley, now a senior economic adviser at Stanford Group Co. in Washington. ``There are a number of the hawkish presidents that would be regarded as solid economists.''

Ahead of the Fed's September meeting, Plosser said officials shouldn't put too much weight on job losses in August, while Fisher said he was ``generally encouraged'' about the economy.

Wrong Call

Such statements led many economists to speculate that Chairman Ben S. Bernanke and his colleagues would split the difference and cut rates a quarter-point. They were wrong. Speeches by Bernanke, Mishkin and San Francisco Fed President Janet Yellen focused more on risks to the economy, and such views may have carried the day.

No official has suggested he would have dissented on Sept. 18. Poole joined the unanimous decision for a half-point cut, saying Sept. 28 it was ``necessary'' given that ``we had a lot of turmoil in markets.'' Plosser called it ``appropriate'' because of slower job growth and lower home prices.

That doesn't necessarily mean all were ``fully comfortable'' with the result, said former Cleveland Fed President W. Lee Hoskins. In fact, the turmoil may have spurred a ``united front,'' he said.

``I would be somewhat surprised if you had a group of people come to a decision without some disagreement, particularly if there's high uncertainty about where inflation and the economy are going,'' said Hoskins, now senior fellow at the Pacific Research Institute in San Francisco.

Bond Sales

This time, the bank presidents' comments come amid evidence that credit markets are recovering from the sell-off that accelerated in August. Issuance of corporate bonds rated below investment grade rose to $6.9 billion since the start of last week, compared with zero sales in the first half of September.

The Institute for Supply Management reported this week that its gauges of manufacturing and services industries both indicated a continued, though slower, expansion in August. Plosser said Sept. 25 that ``much weaker'' data would be needed to change his view.

``The Fed wants to keep all of its options open,'' said Edward McKelvey, senior economist at Goldman Sachs Group Inc. in New York, who used to work at the Fed. ``They leave each FOMC meeting with a fair degree of uncertainty about what they'll do next.''

Last Updated: October 4, 2007 14:58 EDT