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Fed to Raise Rates Three More Times, Bond Dealers Say (Update1)

Fed to Raise Rates Three More Times, Bond Dealers Say

June 30 (Bloomberg) -- The Federal Reserve will raise interest rates at least three more times this year to keep inflation in check, according to a majority of Wall Street's biggest bond dealers.

All 22 primary dealers of U.S. government securities expect Fed policy makers will increase their target rate for overnight loans between banks to 3.25 percent from 3 percent today, a survey by Bloomberg News found. Eighteen forecast a boost to 3.75 percent or higher by year-end, while half the 22 see a rate of at least 4 percent.

Reports that showed consumer confidence at a three-year high, rising home sales and accelerating economic growth bolstered expectations among economists that inflation may quicken. They differ from investors including Bill Gross, manager of the world's biggest bond fund, who see signs of a global economic slowdown and an end to rate increases.

``We're looking for 4.25 percent at the end of the year,' said Michelle Girard, senior economist at RBS Greenwich Capital in Greenwich, Connecticut. ``The market will slowly come around to that view. We're setting the stage for a very solid second half,' she said.

RBS was the first dealer to accurately forecast the target federal funds rate would rise to 2.25 percent in 2004 from 1 percent.

The Conference Board on June 28 said consumer confidence rose to the highest since June 2002. A day later, the Commerce Department said the U.S. economy grew at a 3.8 percent annual rate from January through March, above the original estimate of 3.5 percent. Rising home construction contributed to the gain.

`Measured'

Policy makers have raised the fed funds rate eight times since last June in quarter-point increments. Fed Chairman Alan Greenspan said on June 9 that further increases would likely be carried out at a ``measured' pace.

``The mix of data we have seen has provided enough cross- currents for inflation and growth that the measured pace is the most useful expression about what they ought to do and will do,' said Brian Fabbri, chief economist at BNP Paribas in New York. BNP estimates a year-end target of 4.25 percent.

The rate of inflation as measured by the core consumer price index rose to 2.2 percent in June from 1.1 percent at the start of 2004, and compared with the average of 2.3 percent the past 10 years. The core index excludes food and energy.

`Measured' Language

Among the 16 economists who forecast when the central bank will drop the word ``measured,' only Ian Morris at HSBC Securities USA Inc. in New York said it may happen today. The Fed next meets on interest rates Aug. 9, and has used the phrase in statements from its last nine policy meetings.

``You ask me what is going to happen at the next FOMC meeting and no one cares,' said Kevin Logan, senior market economist at Dresdner Kleinwort Wasserstein in New York. ``What people really care about is what happens in the language.'

Fed rate increases have led to higher borrowing rates for some consumers. Home-equity lines of credit are tied to a bank's prime rate, and New York-based Citigroup Inc., the world's largest bank, has lifted its prime rate to 6 percent from 4 percent the past year, matching the Fed step-for-step.

Economists said rising unit labor costs, and long-term borrowing rates that are below where they were when the Fed started raising rates, are among reasons why the central bank isn't close to being finished.

`A Little More Work'

Wages, benefits and other costs to employers increased 3.3 percent on an annualized basis in the first quarter, almost double the average during the prior 10 years, the Labor Department said June 2. The benchmark 10-year Treasury note's yield, a base for setting corporate and consumer borrowing rates, is 3.99 percent, down from about 4.75 percent a year ago.

These ``suggest the Fed might have a little more work to do to balance financial conditions,' said Neal Soss, chief economist at Credit Suisse First Boston in New York.

Some investors disagree, citing a slowdown in job growth and manufacturing.

Gross, chief investment officer at Newport Beach, California- based Pacific Investment Management Co., said in an interview last week that ``there's a decent chance' the Fed may reduce its target rate early next year.

Interest-rate futures show traders side with Gross. The yield on the September Eurodollar futures contracts ended yesterday at 3.805 percent, indicating traders aren't convinced the fed funds rate will get to 3.75 percent. The futures settle at a three-month lending rate that has averaged about 21 basis points more than the Fed's target over the past 10 years.

Merrill's Stand

Only one dealer, Merrill Lynch, is calling for a rate reduction next year. The firm expects the fed funds target to fall to 3 percent in mid-2006.

``Either June or August will mark the end of the tightening cycle as the Fed tries to glide the economy towards a soft landing,' David Rosenberg, chief North American economist of Merrill Lynch in New York, said in a report dated June 27.

Surging oil prices have had a moderating effect on growth, ``but for the most part the economy stays on its expansion into and through 2006,' said Robert DiClemente, chief U.S. economist at Citigroup.

Crude oil prices are up 40 percent this year, reaching a record $60.95 a barrel on June 27. After its March 22 meeting, the Fed said in a statement that ``the rise in energy prices, however, has not notably fed through to core consumer prices.'

The Fed may say something similar tomorrow, said Glenn Haberbush, an economist at Mizuho Securities USA Inc. in Hoboken, New Jersey.

The following are the results of the survey.

June 30  Dec. 31   June '06    Drop 
 Firm                 Target   Target    Target   `Measured' 
  
 ABN Amro             3.25%    3.50%      4%       N/A 
 BNP Paribas          3.25%    4.25%      4.25%    Q4 
 Banc of America      3.25%    3.75%      4.25%    Q3 
 Barclays Capital     3.25%    4.00%      4.50%    Q4 
 Bear Stearns         3.25%    4.25%      5.00%    N/A 
 CIBC World Markets   3.25%    3.50%      3.50%    N/A 
 Citigroup            3.25%    3.75%      4.00%    Q4 
 Countrywide          3.25%    3.75%      4.25%    Q3 
 CSFB                 3.25%    4.00%      4.50%    Q3 
 Daiwa                3.25%    3.75%      4.00%    N/A 
 Deutsche Bank        3.25%    4.00%      4.50%    2H 
 Dresdner             3.25%    3.75%      3.75%    Q3 
 Goldman Sachs        3.25%    4.00%      4.50%    2H 
 HSBC                 3.25%    3.75%      3.75%    Q2/Q3 
 JPMorgan Chase       3.25%    4.25%      4.50%    2H 
 Lehman Brothers      3.25%    3.75%      4.25%    Q3 
 Merrill Lynch        3.25%    3.50%      3.00%    N/A 
 Mizuho               3.25%    4.00%      4.00%    Q4 
 Morgan Stanley       3.25%    4.00%      4.50%    2H 
 Nomura               3.25%    3.50%      4.00%    Q3 
 RBS Greenwich        3.25%    4.25%      5.00%    N/A 
 UBS Securities       3.25%    4.00%      4.00%    Q3

To contact the reporter on this story:
Al Yoon in New York at at [e-mail]


LINK: http://www.bloomberg.com/apps/news?pid=10000103&sid=aT8TKfjZSR9w&refer=us