Markets at a Loss on Size of Upcoming Fed Rate Cut

Wall Street's top bond dealers are dead certain the Federal Reserve (search) is going to lower interest rates next week, but they are completely flummoxed about the size of the cut.

The source of the confusion comes from dueling articles from two respected Fed-watchers in rival newspapers: the Washington Post on Thursday forecast, without quoting sources, a dramatic half-percentage-point cut, while the Wall Street Journal on Friday cited Fed officials saying a more modest quarter-point cut remains on the table.

Whether the conflicting reports reflect genuine debate among Fed officials about what they should do at next week's policy meeting, or is an attempt to massage market expectations leading into the meeting, is anybody's guess.

"I don't know what the hell these guys are thinking," said one economist who asked not to be quoted by name.

Others saw no shame in admitting to their confusion over the diverging newspaper reports.

"It's baffling, obviously, but we still think they'll go the full 50 (basis points)," said Stephen Stanley, senior market economist at RBC Greenwich Capital Markets.

"We suspect the Fed doesn't want the market to fully price in 50 because then the actual cut won't get much reaction -- less bang for the buck," he added.

The Federal Reserve holds a two-day policy meeting on Tuesday and Wednesday next week, and is seen as being set to lower the 1.25 percent federal funds rate for the 13th time since it starting cutting rates aggressively in January 2001.

The economy's stumbling recovery from the 2001 recession has led to more job losses than during the last "jobless recovery (search)" of the early 1990s, and policy-makers hope that another dose of easier policy will further feed consumers' appetite for houses and cars and keep the recovery afloat.

All the debate in financial markets this week has been on exactly how much "insurance" the Fed will want to take out. Fed Chairman Alan Greenspan (search) said recently that in the face of sluggish growth, insurance is cheap compared to the cost of disappointing growth that could eventually lead to deflation.

But the contradictory press reports of the Fed's supposed intentions have muddied the waters.

"We don't think it's an appropriate way for the Fed to adjust expectations," said Conrad de Quadros, economist at Bear Stearns.

Futures markets have reacted strongly to each report. On Thursday, the July fed funds futures (search) contract jumped to price in a near 70 percent chance that rates will be cut by a half-percentage point to 0.75 percent.

On Friday, those odds retreated to 50-50. A move of a quarter-point is fully priced in and has been for weeks.

"(The reports) show there is some real debate within the Fed whether to go 25 or 50 (basis points)," said Lehman Brothers senior financial economist Drew Matus.

"My view on that is that fortune favors the bold. There is no point now when you have so little ammunition left to conserve any," Matus said.