Economic Expansion Predicted-But with Caveats: With Interest Rates at a 46-Year Low, Volatile Oil Prices, Uncertainty in Iraq and a Presidential Election at Our Doorstep, Just What Direction Will the U.S. Economy Take in the Next Six Months? Many Analysts Say Growth Is in Our Future. but Buyers Beware-This Optimism Is Riddled with Plenty of 'What Ifs.'

By Cavaletti, Carla | Modern Trader, July 2004 | Go to article overview

Economic Expansion Predicted-But with Caveats: With Interest Rates at a 46-Year Low, Volatile Oil Prices, Uncertainty in Iraq and a Presidential Election at Our Doorstep, Just What Direction Will the U.S. Economy Take in the Next Six Months? Many Analysts Say Growth Is in Our Future. but Buyers Beware-This Optimism Is Riddled with Plenty of 'What Ifs.'


Cavaletti, Carla, Modern Trader


Whether you trade Fed funds futures or simply have a stake in U.S. government bonds, being armed with insight on how this summer's interest rate saga will unfold is essential. Most analysts and traders say the Federal Reserve will act in 2004 and raise short-term interest rates for the first time in more than four years. Many believe by the time you are reading this article the market will be absorbing a 25 basis point increase. But the Fed will reconvene again already next month, and traders and investors want a long-term forecast. Just how high will rates go?

Marshall B. Front, chairman of Front Barnett Associates LLC, an independent investment counseling firm in Chicago with more than $1.4 billion in client assets, says that by the end of this year the federal funds rate will be at 1.5% to 1.75%, and could possibly reach 2%.

"Next year I believe rates will be raised another full percent," Front says. "Putting us at 3% by the end of 2005."

Carley Garner, account executive and interest rate trader with Alaron Futures and Options, pegs late summer as the start of the interest rate hike.

"If you would of asked me in mid-May, I would have been 95% sure that the Fed would raise rates on June 30, but new terrorist threats and slightly less positive economic input put a lag on that," Garner says. "August is a better target unless we see hyperinflation in the near term."

Greg McBride, senior financial analyst with Bankrate.com, agrees that this summer will bring increased rates, but, as does Front, he says this is only the beginning.

"This summer's interest rate hikes will likely be the first of many to come in the next 14 to 18 months," McBride says.

Putting himself in Federal Reserve Chairman Alan Greenspan's shoes, Charles Nedoss, senior account manager with Peaktradinggroup.com, explains that he sees value in raising rates between scheduled Fed meetings. He says this provides a shock value that causes investors to take a closer look.

"To get the best bang for the buck, I would do a quarter [point] in June and then say a quarter [point] between June and August," Nedoss says.

But not all traders believe that this economy is in dire need of an interest rate hike. Glen Ring, editor and owner of the newsletter View on Futures, who closely studies the correlation between crude oil and the eurodollar, plays down the need for rate hikes.

"As a generalization, energy prices do not cause inflation and they temper the need to hike interest rates," says Ring, adding that high oil prices actually can siphon excess capital in the economy and eliminate the immediate need to raise rates.

OIL DILEMMA

High oil prices may delay rate hikes, but in the meantime traders have to face the drag these soaring prices put on the greenback. On June 2, the dollar was at a two-month low against the euro. The dollar began this drop after a terrorist attack in Saudi Arabia that was seen as the reason oil prices temporarily reached $41 a barrel.

While oil producer groups cannot stop terrorist attacks, they can quell fears of a summer fuel crunch. On June 3, the Organization of Petroleum Exporting Countries (Opec) decided that it would lift output limits by 2 million barrels a day and by another 500,000 barrels a day starting in August. Fear of inflation was one reason for the unscheduled move, but worries that rising oil prices could slow world economic growth loomed in the background.

Even traders who see energy prices heading lower, such as Michael Malpede, senior foreign exchange analyst with Refco LLC, lean toward predictions of a falling U.S. dollar.

"The dollar may head lower at the end of this year to the start of next year," Malpede says. He says he sees the euro ranging from $1.20 to $1.24 1/2 and the yen at [Ren]108 to [Ren]114 1/2.

Nedoss agrees with the forecast of a near-term dollar decline. …

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Economic Expansion Predicted-But with Caveats: With Interest Rates at a 46-Year Low, Volatile Oil Prices, Uncertainty in Iraq and a Presidential Election at Our Doorstep, Just What Direction Will the U.S. Economy Take in the Next Six Months? Many Analysts Say Growth Is in Our Future. but Buyers Beware-This Optimism Is Riddled with Plenty of 'What Ifs.'
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