Two senior economists at Goldman Sachs see the Federal Reserve raising its benchmark federal funds rate from the current level of 3.5% all the way to 5% in the near future despite the relatively low level of inflation. Jan Hatzius, v.p. and senior economist, and Ed Mc Kelvey, senior economist, said in a recent note to clients that that when the Fed decides to raise rates, it looks primarily at core inflation numbers. Even more important to the Fed outlook on inflation is the core Personal Consumption Expenditure (PCE) deflator. The PCE deflator was increased recently to 1.9% year-on-year. Hatzius and McKelvey said that looking at the PCE deflator provides a less positive outlook on inflation and opens the door for the Fed to raise rates upwards of 5%. Calls to Goldman were not returned.
John Pak of Midanek/Pak Advisors believes the spectrum for the Fed increase is a wide range of anywhere from 4%-5.25%. "The Fed is trying to get rates to neutral. The problem is, nobody seems to know what neutral really is," he said. Pak's co-founder of the firm, Jim Midanek, concurs. "We're not as bearish as those guys [at Goldman] but we definitely think something in that range is possible. However, I'd be very surprised if they raised the 25 basis point range we have been increasing by." Midanek added that although it would be surprising, it remains a possibility given some signs of pressure in the economy and the rising prices of oil.
Univest Wealth Management and Trust senior portfolio manager Gary Wolfer was even less bearish. He said he sees the Fed rate stopping at 4% or, at the highest 4.25%. "I really don't see it, but I have been hearing some rumblings about the possibility of a 4.75% rate, so it's not out of the question," he commented. Wolfer believes that once Fed Chairman Alan Greenspan leaves office on Jan. 31, 2006, the rate increases will slow down markedly if not cease altogether. "The Fed raising rates is definitely a Greenspan thing," Wolfer added.
Wolfer noted that the stock market has been behaving as if it has been anticipating a potentially higher increase. The bond market, on the other hand, has been acting as if it sees the Fed topping out at 4%-4.25%. Wolfer cautioned that the bond market may stall out when the Fed finally stops raising its rates. "Then, if suitable yield stocks look attractive, we could see the bond market fall."
Another industry source said that he did not see the rate getting as high as the level predicted by Hatzius and McKelvey. "I think that the highest that we could see is maybe 4.5%. I really think that the price of oil will filter its way into the economy. The consumer is going to start to feel the pinch and the economy may slow down as early as next year," he added.
