GRINCH AT THE FED?

GRINCH AT THE FED?

he Federal Reserve wouldn't raise interest rates four days before Christmas, would it? Especially not at a time when it is worried about the effects of the Y2K computer bug on the economy? Think again. Fed Governor Edward Kelley said we can't rule out a December rate hike. And the data support such a possibility.

While concerns related to Y2K ''will be an important factor'' in Fed policy considerations when the Federal Open Market Committee meets on Dec. 21, a Fed rate hike is still possible, Kelley said in an article in Barron's.''People have said that Y2K takes the Fed completely out of the picture, but that's too strong a statement,'' he said in the interview, which occurred prior to the release of last Friday's somewhat encouraging employment report.

He added that the Fed has noticed ''we may be getting a little slowing'' in some of the interest-rate sensitive sectors of the economy, but ''everything I see, on balance, tells me there's still a lot of momentum present in the economy.''

Kelley pointed out that the ''wealth effect'' from a rising stock market continues to fuel consumer confidence to high levels. He added that while the Fed officially has a neutral bias at this point, ''there is no question that if the economy continues to go the way it has been going, that will certainly throw the risks to the upside.''

He called third-quarter productivity data ''awesome,'' but cautioned that he's still concerned about the tight U.S. labor market. Fed officials must take note that the economy is running out of workers and that the shrinking labor force has implications for costs and, in turn, prices, he said.

Furthermore, the publication said the Fed governor is also worried about the dollar's slide against the Japanese yen. The softer dollar could increase demand for U.S. exports, he said, which would lead to more demand on a labor force that is already being used to full capacity. The softer dollar could also put further upward pressure on commodity prices, and the inflation picture could deteriorate amid higher-priced imports.

''World growth is good and we strongly support it and we want to see it, but it does create problems in the area of keeping our economy from overheating,'' Kelley added.

He's not the only one who's concerned.

The synchronous expansion in major global economies - assuming that Japan doesn't go into the tank again - will put increasing demands on limited global resources. The warning is clear from the Journal of Commerce Industrial Materials Price Index, a good leading indicator of inflation.

The JOC index is rising at an annual rate of more than 8 percent. Rising prices at the factory-input level are likely to be felt by consumers six to nine months later.

The Fed cannot afford to wait until its early-February meeting (there is no meeting scheduled in January) to take action. The U.S. economy is heating up, and another tap on the brakes is needed now.

Strong U.S. economic conditions and a tight labor market mean the Fed is likely to raise interest rates by 50 basis points during the first part of next year, Salomon Smith Barney said in its weekly Comments on Credit report. With growth estimates continuing to climb, the chances for additional Fed tightening have inched up as well.

''The challenge remains for Fed policy-makers to engineer a slightly less spectacular growth path that keeps inflation risks in check,'' the report said.

The November employment report did little to alter the need for the Fed to moderate economic growth while watching over inflation, it said.

''The job market remains very strong even if measures of labor slack did not tighten further in November,'' Salomon said. ''The index of hours worked appears on track to post a gain of roughly 2.5 percent for the quarter, while the recent pace of hiring according to both household and establishment surveys is running ahead of population trends.''

If the Fed does raise rates on Dec. 21, it will be in a better position to lower them later if Y2K turns out to be a real problem, although we don't think it will. At the very least, the Fed needs to adopt a tightening bias to put the markets on notice that there will be further rate hikes in 2000 and that it is not falling hopelessly behind the inflation curve.

U.S. gross domestic product rose at an astonishing annual rate of 5.5 percent in the third quarter and shows little sign of slowing much in the fourth quarter. With increasing concerns about a pick-up in inflation, the Fed has little choice but to put a lump of coal in investors' stockings.