Fed prepares for rate hike

Associted Press

Washington, May 3:

A replay of 1994?

That’s one question facing Federal Reserve policy-makers when they meet tomorrow and try to determine how an economy accustomed to super-low interest rates will react to rising rates. A decade ago, shock waves from rate increases contributed to financial disasters in Mexico; Orange County, California; and elsewhere. Analysts do not expect that Fed chairman Alan Greenspan and his colleagues will start raising rates this week. Many expect the central bank will start preparing the country for higher rates, in large part to avoid the mistakes of a decade ago.

“They want to be very cautious this time around because they want to avoid an outcome like 1994,” said David Jones, who has written four books on the Greenspan Fed. In 1994, the Fed began a yearlong series of seven increases that would double an important rate to six per cent. Since midyear, the Fed had kept its target for the federal funds rate — the interest that banks charge each other — at a then-low three per cent.

The first increase came February 4, 1994, and led to a huge sell-off on Wall Street. Before the Fed was done raising rates, the financial market fallout helped sink Orange County, the Mexican peso and a venerable Wall Street firm, Kidder Peabody & Co. Today, a rebound in job growth and emerging signs of possible inflationary pressures have financial markets nervous that another long period of low interest rates is drawing to a close. The funds rate is one per cent, a 46-year low. It has been there since June and has not climbed above two per cent for more than two years.

Even Greenspan’s oblique reference on April 20 about the possibility of higher rates was enough to send the Dow Jones industrial average plummeting, 120 points in a single day. Since then, stocks have sagged. The Nasdaq composite index last week fell by 6.4 per cent, its worst weekly performance since October 2002.