Fed likely to hike rates despite Katrina

So far the Fed has gotten only an early glimpse at data showing how the storm is affecting the national economy.

Consumer sentiment took its biggest one-month plunge in 25 years, University of Michigan researchers reported Friday, reflecting anxiety over high energy prices and other fallout from the storm. But gas prices already have dropped sharply from post-storm peaks, and falling sentiment does not necessarily translate to lower consumer spending.

New claims for unemployment already have surged and likely will go higher, the Labor Department said this week.  Industrial production was lower than expected in August because Katrina disrupted refining activities, chemical manufacturing and oil and gas extraction from the Gulf at the end of the month, the Fed said in a monthly report. September production no doubt will be curtailed further.

“If I were still there I would be arguing … they ought to pause and not do anything and just see where it goes,” former Dallas Fed President Robert McTeer said in an interview last week.

McTeer, now chancellor of the Texas A&M University system, noted that the Fed already has hiked the overnight bank lending rate to 3.5 percent from 1 percent in mid-2004. “I don’t see any harm in letting the economy digest that and seeing where it goes,” he said.

McTeer was well-known as an inflation “dove” who generally favored lower rates in his time at the Dallas Fed, which included a rotating seat as a voting member of the policy-making Federal Open Market Committee from 1991 through 2004.

Current Fed policy-makers have been circumspect.

“In addition to the potential negative effect on growth, rising oil prices, like other unfavorable cost shocks, can also feed through and raise underlying core inflation,” Chicago Fed President Michael Moskow said in a speech last week. “So there is also a risk on the inflation front, and the risk is higher now than it was a year ago.”

“They probably will raise rates,” said Mary Ann Hurley, a bond trader at D.A. Davidson & Co. in Seattle. “But given the fact that we don’t know how Katrina is going to affect the economy, they would be very prudent to wait.”

She said Fed officials probably will raise rates in part to avoid a negative reaction from investors, who might read a pause as a signal that an economic slowdown is imminent.

“The other thing that could be the tipping point is going to be their concern for the housing sector,” she said. “They are not going to want to do anything that adds to the froth in the housing market.”

While the Fed has hiked short-term rates steadily since June 2004 and signaled its intention to continue raising them at a “measured” pace, long-term mortgage rates have held steady, buoying the red-hot housing market. The current average 30-year rate of 5.74 percent actually is below the 6.29 percent level of mid-2004, according to mortgage giant Freddie Mac.

If anything, the destruction wrought by Katrina is likely to increase demand for housing, especially as massive federal aid and private insurance money flows into the Gulf Coast region next year.

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