The U.S. economy limped tenaciously through the second quarter. Although last week's consumer confidence numbers give some credence to the theory that the economy has suffered nothing more than a transient soft patch, is it ready for another round of interest rate hikes? The Fed Funds Futures contract is pricing in a 70% probability that the Federal Open Market Committee will implement a 25-basis point increase the next time it meets.
Investors are now accustomed to an accommodative Federal Reserve Board, and it seems that no one wants the low interest rate party to be over. During the first quarter of 2004, about 80% of investors responding to the UBS/Gallup Index of Investor Optimism survey thought that the Fed should cut rates or hold them at the same level over the next three months. That sentiment has moderated somewhat in recent months, although 67% of investors in the August 2004 investor survey* are still against tightening.
But investors are not in denial about the probability of additional rate increases. A majority of investors -- 57% -- think a rate hike is in the cards when the FOMC meets in September. Thirty-four percent think the Fed will hold the line on interest rates, and only 5% expect a cut.
Interest Policy Approval
Does the disconnect between their preferences and expectations mean investors are down on the Fed's interest rate policy? Over the past four years, Gallup has asked investors for their opinion on Fed interest rate policy, a question consistently met with a high percentage of "don't know" responses (42% in the August 2004 survey). The high percentage of "don't knows" suggests that the intricacies of monetary policy and the inner workings of the Federal Reserve remain mysterious to many investors. Nevertheless, just under half (48%) of investors say they approve of the Fed's current interest rate policy, while 10% disapprove.
The data clearly suggest that investors are much more likely to give the Fed a positive rating than a negative rating. Among investors who do know enough about Fed policy to venture an opinion, 84% say they approve and just 16% disapprove.
Policy Loses Cheerleaders
The UBS/Gallup survey also asks investors how strongly they approve or disapprove of Fed policy. Over the last 3 1/2 years, a core group of investors -- usually in the range of 20% to 30% -- have reported that they "strongly approve" of the Fed's policy stance. Currently, 24% of investors overall say they strongly approve of Fed policy.
However, examining the trend of "approve strongly" responses shows that the Fed has lost a little ground in the last two months among investors who have an opinion about Fed policy. Last June, 49% of all investors who had an opinion about Fed policy strongly approved of it; in August, 41% of investors who have an opinion one way or the other approve of it strongly.
Bottom Line
Traders looking for clues on where rates are headed eagerly anticipated Fed Chairman Alan Greenspan's address to Central Bankers at Jackson Hole, Wyo., last Friday. However, the chairman's focus was on the Social Security system, deficits, and the retirement age, providing Fed watchers with little color on monetary policy or economic outlook.
This Friday, when the Bureau of Labor Statistics releases the August jobs report, the market should have more definitive evidence on whether the economy is ready for the rate increase the doctor might order. Barring a particularly disappointing payroll number for August, the announcement of a 25-basis point FOMC rate hike on Sept. 21 will not surprise investors.
*Results for the Index of Investor Optimism -- U.S. are based on telephone interviews with a randomly selected U.S. sample of 804 adult investors, aged 18 and older, with at least $10,000 of investable assets, conducted Aug. 1-15, 2004. For results based on this sample, one can say with 95% confidence that the maximum error attributable to sampling and other random effects is ±4 percentage points. In addition to sampling error, question wording and practical difficulties in conducting surveys can introduce error or bias into the findings of public opinion polls.
