fed won't raise rates ... ever ... well, almost ...
=DJ FED WATCH: Goldman Goes Long - Really Long - On
Fed Call
(This article was originally published Thursday)
By Michael S. Derby
A DOW JONES NEWSWIRES COLUMN
NEW YORK (Dow Jones)--Long in the vanguard of banks that see the Federal Reserve keeping interest rates low for a long time, Goldman Sachs just edged a bit further out onto the bleeding edge.
The bank suggested in a research note that the Fed may never again hike interest rates while Fed Chairman Alan Greenspan is holding the reigns at the central bank. For those keeping score, that means a steady Fed until sometime in 2006.
For quite some time, Goldman Sachs analysts have argued that the Fed, faced with an economy defined by a large divide between actual and potential growth levels, will be keeping what's currently a 1% federal funds rate in place for a long time.
And it's this so-called output gap that's looked to by many forecasters, along with Federal Reserve officials, as the main determinant of inflationary pressures. The farther the economy is under potential, and the longer it stays there, the lower the inflation pressure it's likely to face.
And it's inflation that remains at the forefront of the Fed's focus. Indeed, Fed officials from Chairman Alan Greenspan on down have all said that even with growth heating up, the dearth of meaningful price pressures is what takes pressure off the central bank to raise rates.
Goldman, along with banks such as Citigroup, Credit Suisse First Boston, HSBC Securities, Lehman Brothers and Merrill Lynch, all agree the Fed won't be doing anything this year with interest rates, even though a modest majority of banks that deal directly with the Fed - called primary dealers - still favor some sort of rate hike action much later this year.
The latter camp grew smaller last Friday, after the government released dismal February jobs data. Financial markets also priced securities and futures contracts for a much-reduced chance of central bank interest rate action this year.
Goldman Sachs says the Fed wants inflation higher and trends are still not moving in the direction, and may not for some time. Which leads to their argument and forecasts for the all important output gap.
Ugly Roadmap
"Based on conservative assumptions, it is unlikely that the (gross domestic product) gap will close before mid-2005 and, therefore, that the (Federal Open Market Committee) will tighten before then," Goldman Sachs economist Ed McKelvey argued in a research note from Wednesday.
"To close the gap in a year, the economy needs to grow by the sum of the GDP gap and the potential growth rate. If the gap is 2% and the potential growth rate is 3%, then 5% growth would be required to close the gap by the spring of 2005," he said.
McKelvey flags the fact that the needed level of growth is well above what economists in the latest monthly Blue Chip economic indicator poll are predicting. And if the Blue Chip forecasters - the poll is the definitive forecaster survey - are right about 4% growth, the output gap won't close until early 2006.
And that's right around the time when Greenspan, at the top of the Fed since 1987, will be leaving the job. His term ends on Jan. 31, 2006.
"This raises a tantalizing question - have we seen the last tightening from Mr. Greenspan?," the Goldman economist asked.
Perhaps in a recognition of the dangers of all long term forecasts, McKelvey admits he's not yet willing to follow where the forecast may be pointing. "We won't push the point other than to note that there is some risk that our expectation of tightening in mid-2005 could be premature," he wrote.
(Michael S. Derby writes about markets, the economy and
the Federal Reserve for Dow Jones Newswires.)
-Michael S. Derby, Dow Jones Newswires; 201-938-4192;
michael.derby@dowjones.com
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