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Will Fed Hike Rates On Tuesday or Not?

WALL Street is watching the Federal Reserve with the fascination of a tourist staring at an Indian fakir's coiled cobra.

The consensus of financial experts is that the Fed will strike Tuesday, with its policymaking Open Market Committee (FOMC) deciding to increase short-term interest rates. But in remarks to a House subcommittee last Wednesday, Fed chairman Alan Greenspan gave no clear clue as to next Tuesday's decision. Nor was the economic news for July - which was released yesterday - decisive. Wholesale prices were up decidedly because of higher oil and coffee costs. But retail sales slipped 0.1 percent.

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``The Fed will most likely raise rates by another 50 basis points [one half a percentage point],'' reckons Wayne Angell, an economist who resigned as a governor of the Fed last February and became chief economist of Bear, Stearns & Co., a New York brokerage house.

Wall Street is split between the expectation of 25 or 50 basis points, says James Glassman, an economist with Chemical Bank in New York. Since February, the central bank has hiked its target for the rate commercial banks charge each other on overnight loans from 3 percent to 4.25 percent. The action prompted long-term rates to rise also, including mortgage costs.

One reason for the Fed to move immediately on interest rates is a matter of diplomacy. Fed officials do not want to be seen as acting politically. If they wait for the next meeting of the FOMC in September, they will be getting close to the November congressional elections. Another interest-rate hike aimed at restraining inflation could be regarded as damaging to Democratic prospects.

H. Erich Heinemann, a Fed watcher with Ladenburg, Thalmann & Co., says the FOMC will postpone action. Higher interest rates, he says, would increase the risk of a recession in 1996 (not 1995). That's because monetary policy is tight, he says, and such a change takes a long time to affect the real economy. Total reserves in the banking system have declined since last February, he notes. When banks have abundant reserves, they can make more loans and create new money in the economy.

Heinemann calculates that the drop in reserves has meant that the economy has $70 billion less money than it might otherwise have. This reduction in the flow of liquidity into financial markets has contributed to weakness in the price of paper assets. ``As long as the Fed continues to drain funds from the banking system, a sustained rally in either stock or bond prices is unlikely,'' he says. Moreover, fiscal policy is tight, he adds. If interest payments on oustanding federal debt are excluded, the ``primary'' federal budget was in surplus so far this year. Heinemann uses this budget measure because he figures that interest payments on the debt have little impact on the economy. The government borrows from the public and then promptly puts the money back into the economy as interest payments. A large part of that interest is reinvested in Treasury debt instruments.

Despite the present ``risk of monetary overkill'' for the economy, Heinemann predicts that the inflation rate will rise. That, he says, has been built into the economy by the Fed's ``mistaken'' rapid provision of reserves to banks prior to this year.

But David Levy disagrees. The economic forecaster for the Jerome Levy Economics Institute in Mt. Kisco, N.Y., says the economy is different from what it was in the 1970s. Far fewer employees enjoy cost-of-living provisions in their work contracts, clauses that create additional inflation in the future by upping wage costs. Mr. Levy also sees a ``culture of wage stability'' having taken root, with unemployment still above 6 percent, massive layoffs continuing, and many fearing for their jobs. Many employees no longer take a rise in living standards for granted. They have been accepting an average annual wage increase of about 3 percent, barely above inflation.

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Moreover, productivity in the 1990s should do well because relatively few new, inexperienced workers are being hired, he says. The labor force is growing about 1.3 percent annually, compared with 2.9 percent in the 1970s when women and the Baby Boom generation were starting work in massive numbers. Productivity is being helped by a pared down, cost-conscious corporate culture, he adds.

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