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What to Expect from the Fed

by BW staff

The Federal Reserve began its two-day policy meeting Apr. 28 amid hopes that the U.S. economy may soon turn the corner. But any nascent economic recovery could be threatened by the swine flu epidemic, which showed signs of spreading on Apr. 28.

What can investors expect from the Fed? What economic impact could the swine flu outbreak have? BusinessWeek collected the thoughts of Wall Street economists on these and other topics on Apr. 28:

Action Economics

While we expect the Fed to pause and take stock of current conditions, with the zero bound on the [Fed] funds rate constraining any further reduction in interest rates, there is some risk of additional quantitative easing measures. Currently the Fed has an alphabet soup of liquidity programs on the table, including the $300 billion Treasury purchase plan announced after the March Federal Open Market Committee [meeting]. Policymakers also announced at that time that they were considering expanding the range of eligible collateral, to include financial assets, for its Term Asset-Backed Securities Loan Facility. Note, too, that Pimco fund manager Bill Gross spoke on Bloomberg radio [on Apr. 28] and suggested the FOMC could add to its Treasury purchase program if the 10-year note yield climbed to the 3%-to-3.10% range. Remember that a big part of the Fed's rationale for purchasing Treasuries was to knock mortgage rates lower to stimulate the housing sector.

We do expect the Fed to reiterate that it will use all tools available to promote economic growth, and that it will keep rates "extraordinarily low" for an "extended period." Also of note, while the Fed will reiterate the economy remains weak, there could be some sign of hope on a recovery as was seen in the [Apr. 15] Beige Book.

Jay Bryson, Wachovia Securities

If the current swine flu epidemic ends up infecting millions of people, then global [gross domestic product] could be adversely affected at a time when the global economy is already in its worst recession in decades. If, however, the current epidemic ends up being about as virulent as the SARS outbreak of 2003, then Mexico will likely suffer a short-term economic setback but the overall effect on global GDP is likely to be rather small. Under a "mild" scenario global GDP would be reduced by 0.7% (about $400 billion). A "moderate" scenario would result in a loss of 2% of world GDP (roughly $1.2 trillion). A "severe" scenario leads to a reduction in global GDP of nearly 5% (about $3 trillion).

By the reckoning of three economists, about 60% of the losses occur via demand side effects (e.g., disruption of travel, curtailment of nonessential retail shopping, etc.). Nearly 30% come from temporary supply side effects like illness and absenteeism. The remainder comes from mortality.

Tony Crescenzi, Miller Tabak

The Conference Board's consumer confidence survey's better-than-expected results [in April] do not alter the dismal way in which consumers continue to view the economy, but they fit the "green shoots" idea currently driving market prices. Eventually, focus will shift to both the sustainability and depth of recovery. This should cap gains in riskier assets for a time.

The bulk of the increase in today's index was in the expectations component. It increased to 49.5 from 30.2 in March. The present situation index increased just 1.8 points, to 23.7. Expectations can't be spent; hence, the index on the present situation speaks to the wherewithal to spend, which is weak. The percentage of respondents that plan a vacation fell to a record low 33.9% of respondents. The figure tends to be around 40% to 45%. Plans to purchase a home edged up to 2.5% from 2.4%, matching January's level. Plans to purchase a car increased to 4.8% from 4.0%, also matching January's level.

Beth Ann Bovino, Standard & Poor's

The S&P Case/Shiller 20-city home price index fell 2.17% in February to 143.17 from 146.35 in January, the 26th consecutive monthly decline. The index is down 18.63% over last year, narrower than the -19.0% seen in January. It is the first time in 16 months that the index did not post a new year-over-year record decline. The 10-city composite index fell 2.08% to 154.70 from 157.98 in January. The 20-city index is now down 30.7% from its peak in July 2006. All 20 cities posted year-over-year price declines, with 16 cities seeing double-digit declines. Cities posting the largest declines were Phoenix (-35.2%), Las Vegas (-31.7%), and San Francisco (-31.0%).

While the pace of the year-over-year decline has slowed, to offer markets one more sign that housing markets are starting to stabilize, one month is not a trend. A few more months of data are needed to see if home prices have hit bottom.

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