Fed’s Krozner Talks Down Rate Cuts; Goldman Talks Up Recession

Two contrasting stories on Bloomberg: Federal Reserve Governor Randall Kroszner made the most explicit statement by a Fed official to date, saying that further rate cuts aren’t needed to get the economy through its “rough patch.” Although Fed futures declined, the implied expectation of a rate reduction is 84%.

Yesterday, Goldman’s chief economist Jan Hatzius issued a report that pegs the subprime-triggered reduction in lending at $2 trillion and foresees a “substantial recession.” A forecast that grim demands further interest rate reductions.

First, from the story on Kroszner:

Federal Reserve Governor Randall Kroszner said policy makers probably won’t need to reduce interest rates further to help the economy weather a “rough patch” in the coming year.

“The current stance of monetary policy should help the economy get through the rough patch during the next year, with growth then likely to return to its longer-run sustainable rate,” Kroszner said today in a speech in New York. Data consistent with such growth “would not, by themselves, suggest to me that the current stance of monetary policy is inappropriate.”

The comments represent the most explicit message from a Fed policy maker since the Oct. 31 rate cut that officials are reluctant to lower borrowing costs further. The chance of a quarter-point cut at the Dec. 11 meeting dipped to 84 percent from 90 percent after Kroszner’s remarks, according to futures prices on the Chicago Board of Trade.

“The downside risks to economic growth now appear to be roughly balanced by the upside risks to inflation,” Kroszner said, echoing the Federal Open Market Committee’s Oct. 31 statement. “I would add that the limited data and information received since the October FOMC meeting have not changed my thinking in this regard.’….

“One feature of monetary policy to keep in mind is that, all else equal, each successive action in the same direction tends to lower the incremental benefits and to raise the incremental costs of additional actions,” Kroszner said.’

And from the Goldman piece:

The slump in global credit markets may force banks, brokerages and hedge funds to cut lending by $2 trillion and trigger a “substantial recession” in the U.S., according to Goldman Sachs Group Inc.

Losses related to record home foreclosures using a “back- of-the-envelope” calculation may be as high as $400 billion for financial companies, Jan Hatzius, chief U.S. economist at Goldman in New York wrote in a report dated yesterday. The effects may be amplified tenfold as companies that borrowed to finance their investments scale back lending, the report said.

“The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognized,” Hatzius wrote. “It is easy to see how such a shock could produce a substantial recession” or “a long period of very sluggish growth,” he wrote.

Goldman’s forecast reduction in lending is equivalent to 7 percent of total U.S. household, corporate and government debt, hurting an economy already beset by the slowing housing market. Wells Fargo & Co. Chief Executive Officer John Stumpf said yesterday that the property market is the worst since the Great Depression…..

Hatzius said his report is based on a “conservative estimate” of financial companies cutting lending by 10 times the loss to their capital. Investors realizing half of the potential losses, at $200 billion, would have to scale back lending by $2 trillion, he said.

“The response to those kinds of risks is to lower interest rates, and we think the Fed will lower interest rates,” Hatzius said in an interview today. Goldman predicts a quarter-point cut when the Fed meets on Dec. 11.