Fed policymakers
replaced assurances that they would keep interest rates low for "a considerable
period" with the a promise to "be patient" about raising them.
By Peter G. Gosselin
Times Staff Writer
January 29, 2004
WASHINGTON — The Federal
Reserve voted Wednesday to leave interest rates at 45-year lows, but its
statement accompanying the decision was seen by investors as a first step
toward an eventual rate hike.
The statement drove down stock prices and set off renewed debate about
when the central bank might raise rates — a decision that could affect the
presidential race and slow an economy that has been recovering partly because
of low rates on mortgages and other loans.
Many economists said the Fed was unlikely to hike rates before the
November election, at least in part because Fed Chairman Alan Greenspan does
not want to be seen as influencing the political process or hurting President
Bush's reelection prospects. Bush's father blames Greenspan for the weak
economy that is widely thought to have kept him from winning reelection in
1992.
In Wednesday's decision, members of the central bank's policymaking
Federal Open Market Committee voted unanimously to leave its signal-sending
federal funds rate at 1%. The rate, which banks charge each other for short-term
loans, has been at that generational low since June.
But in their accompanying statement, Fed policymakers replaced assurances
that they would keep rates low for "a considerable period" with the slightly
more tepid promise to "be patient" about raising them.
That was enough to drive stock and bond prices down, while market-set
interest rates rose. The dollar rallied against other currencies.
The Dow Jones industrial average tumbled 141.55 points, or 1.3%, to
10,468.37. The dollar jumped 2 cents against the euro, a huge increase in
a market where tiny changes are worth billions.
Economists interviewed after Wednesday's decision said the word change
had much more to do with the Fed's trying to extricate itself from a rhetorical
cul-de-sac than with the timing of eventual rate hikes.
Stock and bond traders had become fixated on the phrase "considerable
period," asserting that its continued appearance in Fed statements since
August showed that policymakers intended to keep rates low indefinitely.
The abrupt reaction suggested how uncertain investors and forecasters
still were about the economy despite the pickup in growth since last summer.
A rate increase anytime soon would drive up mortgage and credit card
costs, probably dampening the red-hot housing market and possibly playing
havoc with election-year political calculations. President Bush is seeking
to convince Americans that, after three years of setbacks, the economy is
finally on the road to recovery.
"Fed officials felt constrained by their 'considerable period' language
and they wanted to give themselves the option to [raise rates] if they need
to," said David M. Jones, a veteran Fed watcher and president of DMJ Advisors,
a Denver consulting firm.
But, Jones added, the central bank is unlikely to raise rates before
the November election. Fed officials may have felt some pressure to begin
signaling a readiness to raise rates by Friday's scheduled release of economic
growth figures for the October-December quarter.
Economists have been nudging up their predictions of the pace at which
the nation's gross domestic product expanded during the quarter, from 4%
to 5% or higher. If they're right, that would mean the economy has been expanding
at a powerful clip for six months, which raises the risk that inflation —
which recently has been almost nonexistent — could pick up and force the
central bank to step on the brakes. The economy grew at a stunning 8.2% pace
during the July-September quarter.
Economists believe that part of what has been keeping inflation in
check is that while growth has picked up, employment has not. According to
Labor Department figures, the economy has added only 275,000 jobs since August.
The result has been painful for people looking for work, but it has allowed
employers to hold down costs and prices.
Fed officials acknowledged in their statement Wednesday that "new hiring
remains subdued." But they added that "other indicators suggest an improvement
in the labor market."
The officials did not say what indicators they were relying on. But
economist Mark Zandi of Economy.com, a West Chester, Pa.-based forecasting
firm, said they probably were looking at recent declines in initial claims
for unemployment compensation.
Zandi said he estimated from claims data that employers had added 450,000
jobs since August, considerably higher than the Labor Department's figures.
Analysts said that if the nation began generating growth and jobs in
tandem, the economy would be on its way to a full recovery. But it would
also be closer to the day when inflation would begin to pick up and the Fed
would need to raise rates.
Analysts said part of the reason for the market's abrupt reaction Wednesday
was that Fed officials gave no advance notice in recent speeches and public
comments that they planned to change their public statement or drop the phrase
"considerable period."
"The markets are overreacting, but I do fault [officials] for not giving
them a heads-up," said Jones, the Denver-based Fed watcher.
Even with the sharp reaction, analysts described Wednesday's stock
market losses as modest — particularly in the context of the gains over the
last 10 months.
The Dow's percentage drop was its biggest since Oct. 22, but the blue-chip
index is still up 39% from its pre-Iraq war low reached March 11.
The interest rate on the 10-year U.S. Treasury note, a benchmark for
long-term interest rates, jumped to 4.19% on Wednesday from 4.08% on Tuesday,
as some investors sold bonds on concerns that the Fed might tighten credit
sooner rather than later. Bond yields move in the opposite direction of their
prices.
But the Treasury note yield had soared from a generational low of 3.11%
last June to as high as 4.6% by early September, as the economy improved
and more investors began to assume that the Fed would be raising interest
rates eventually.
"The smart money has been looking for higher interest rates anyway,"
said Kevin Caron, market strategist at investment firm Ryan Beck & Co.
in Livingston, N.J.
Historically, the stock market often has been able to continue rising
in the face of higher interest rates if the reason for tighter credit is
a stronger economy, analysts note. A healthier economy typically translates
into rising corporate earnings, which underpin share prices.
Despite Wednesday's pullback, "I still think people are looking to
get [into] stocks," said Todd Clark, a trader at Wells Fargo Securities in
San Francisco.
Times staff writer Tom Petruno in Los Angeles contributed to this report.
*
(BEGIN TEXT OF INFOBOX)
Fed interpreter
Recent statements from the Fed and what they really mean:
Statement (used when the Fed made a surprise rate cut in January 2001): "There is little evidence to suggest that … gains in productivity are abating."
Translation: Even though the economy is bad and we must
cut rates, our sunny predictions about the technological wonders of the "new
economy" are still coming true.
Statement (used when the Fed last cut rates in June): The Fed would continue to pursue an "accommodative stance" of monetary policy.
Translation: This economy still isn't rockin'. We're cutting rates to give it another boost.
Statement (first used in August): The Fed would keep interest rates down for "a considerable period."
Translation: Relax. We won't raise rates while this economy still isn't so hot.
Statement (used Wednesday): The Fed "can be patient" in removing its low rate policy.
Translation: Wake up. We might eventually hike rates, although it won't happen immediately.
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