Further cuts by Fed are expected this year
Economy is seen as near stalling point
WASHINGTON - Government bond traders, who predicted six of the last seven recessions, say the Federal Reserve will lower interest rates again before year-end as the economy comes to a standstill.
Since the Fed last week lopped half a percentage point off the central bank's target for overnight lending between banks - the first orchestrated decline in so-called federal funds since 2003 - traders have pushed the yield on Treasury two-year notes to almost three quarters of a point below the designated 4.75 percent funds rate. In the three previous occasions during the past 20 years when that has happened, policy makers have cut borrowing costs.
"The US economy needs to grow at 2.5 to 3 percent or else it stalls," said Bill Gross, manager of the $104.4 billion Total Return Fund, the world's biggest bond fund. "Historically every time we get close to stall speed the Fed lowers short rates." The latest government data show unexpected job losses in August, sagging core retail sales, and no relief in sight for the housing market. Now that US gross domestic product probably is growing at an annualized rate of less than 2 percent, speculation is rampant that another Fed rate cut is assured.
Even former Fed chairman Alan Greenspan provided encouragement to traders when he said in an interview two days after the central bank's Sept. 18 rate decision that the odds of a recession remained "somewhat more" than one in three.
Gross, who is chief investment officer of Newport Beach, Calif.-based Pacific Investment Management Co., has predicted lower borrowing costs for a year. He said the federal funds rate will drop to at least 3.75 percent as housing causes the economy's growth rate to slow to between 1 and 2 percent from 4 percent in the second quarter.
"The market is anticipating there could be some further rate cuts down the line," said James Sarni, senior managing partner at Payden & Rygel in Los Angeles, which manages $54 billion. "There has been a shift in the balance of what's driving the Fed from concern about inflation to more concern about growth."
At all 11 of their regular meetings from May 2006 until this past Aug. 7, policy makers said inflation was the main risk facing the economy. Last week they said only that "some inflation risks remain."
What changed for the Fed was the first drop in US employment in four years in August, an unexpected decline in retail sales excluding automobiles, and the inability of borrowers to roll over short-term debt. 