Officially, the Federal Reserve Board still is worried that the U.S. economy is too strong and that higher interest rates might be needed to slow growth and subdue inflationary pressures.
But financial markets seem to have a much different view of the central bank's probable next move with rates--namely, a cut rather than an increase.
For U.S. consumers and businesses, the stakes are significant either way, of course. A rate boost by the Fed could depress economic activity and make credit tougher to get. A rate cut could have the opposite effect and thus naturally would be welcomed by households and businesses.
The markets' apparent optimism about a rate cut was reflected last week in a rare occurrence: In the U.S. Treasury bond market, yields on bonds of every maturity--from three-month Treasury bills to 30-year Treasury bonds--were below the Fed's benchmark short-term interest rate, the federal funds rate.
Normally, the federal funds rate, which is what banks pay to borrow from each other overnight, is supposed to be the "floor" for U.S. interest rates, as set by the Fed.
But while the Fed has been holding the federal funds rate at 5.5% since March 1997, investors late last week pushed the annualized yield on 30-year Treasury bonds to a record low of 5.44%.
That means some investors now are willing to accept a lower rate to commit their money for 30 years than they could earn in some short-term money market funds.
It doesn't take an economics degree to understand the seeming illogic there. Long-term interest rates are supposed to be higher than shorter-term rates to compensate investors for the greater risk entailed in tying up their money at a fixed rate for an extended period.
Then why have Treasury bond yields fallen through the Fed's rate floor?
Historically, that has happened when investors have become convinced that the Fed is on the verge of cutting its key short-term rate.
And because the Fed generally reduces rates only when it starts to worry that the economy needs help to avoid a recession, an interest-rate "inversion"--short-term rates above long-term rates--often has heralded a sharp economic slowdown.
"We're almost assuredly on course for a slowdown," said Paul Kasriel, an economist at Northern Trust Bank in Chicago.
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Economist Henry Kaufman at Kaufman & Co. in New York believes that although the U.S. economy might not show outward signs of slowing in the next few months, "chances have improved that [the Fed's next move] will be to lower interest rates" in 1999.
