Fed starts two-day meeting, rate cut size debated

A pedestrian passes in front of the Federal Reserve Building in Washington January 22, 2008. The Federal Reserve began a two-day meeting on Tuesday that was expected to end with the second interest rate cut in just over a week, but market confidence in an aggressive half-percentage point drop was waning.

WASHINGTON (Reuters) - The Federal Reserve began a two-day meeting on Tuesday that was expected to end with the second interest rate cut in just over a week, but market confidence in an aggressive half-percentage point drop was waning.

A Fed spokesman said the Federal Open Market Committee began its meeting at 2 p.m. EST. A statement outlining the central bank's rate decision is expected to be released at about 2:15 p.m. on Wednesday.

The Fed is mulling its next step to bolster the economy after stunning markets on January 22 with its biggest rate reduction in more than 23 years -- an emergency move that brought the benchmark federal funds rate down three-quarters of a point to 3.5 percent.

Since then, investors have widely bet the Fed would keep slashing to head off a recession given worsening financial market conditions.

But after stronger-than-expected data on consumer confidence and durable goods orders on Tuesday, investors scaled back bets on a half-point move significantly.

Short-term interest rate futures showed the implied chances for a half-point cut had dipped as low as 60 percent by midday on Tuesday from 86 percent on Monday. A quarter-point cut was still fully priced in.

New orders for long-lasting U.S.-made manufactured goods rose 5.2 percent last month, the Commerce Department said, well above the 1.5 percent increase expected on Wall Street. The data suggested that the economy, aided by exports, may be healthier than some analysts have believed.

Separately, the Conference Board said its index of consumer sentiment fell to 87.9 in January from an upwardly revised 90.6 in December. Analysts had expected a reading of 87.5, and some said the data reflected consumer worries about housing and stock markets, but more confidence in jobs.

"This is not the kind of data recessions are made of, and highlights how important employment is going to be in determining whether the economy can sneak by with a growth recession -- growth where unemployment rises -- or something much less benign," said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut.

The Fed's decision, however, will come before the all-important January U.S. payrolls report on Friday. Non-farm job creation dwindled to just 18,000 in December, but analysts polled by Reuters are predicting January job growth of 63,000.

(Editing by Andrea Ricci)