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Fed Leaves Rate At 1%, But Lays Groundwork For A Future Tightening
Thursday
January 29, 10:10 am ET
By Jed Graham The Federal Reserve held its
key interest rate at a 45-year low of 1% Wednesday and signaled it's in no hurry
to wean the economy from its aggressively stimulative monetary policy. But
the Fed watered down its assurance that no rate hike would be needed "for a considerable
period," saying instead that it "can be patient" in tightening policy. Treasuries
retreated after the Fed's statement, with 10-year yields backing up to 4.19% from
4.05% just prior to the announcement. That move reversed most of the decline in
bond yields that followed the surprisingly weak December employment report on
Jan. 9. Stocks also gave up some recent gains after the Fed statement, with the
S&P 500 falling 1.4% and the Nasdaq 1.8%. No Rush To Hike Rates Noting
that inflation was muted and hiring "subdued," the Fed continued to see roughly
equal risks of economic weakness and an overheating economy in the next few quarters.
Likewise, the chances of inflation falling too low remained on par with the odds
of rising inflation. Because the bond market has been so strong and inflation
has been especially tame, the timing was right for the Fed to drop the "considerable
period" assurance, John Caldwell, chief investment strategist at McDonald Financial
Group, predicted this week. Core consumer prices rose just 1.1% last year,
the smallest annual gain in 43 years. 
"The economic data can support the idea that rate hikes are not imminent,"
Caldwell wrote. "While we could see some volatility surrounding the announcement
on Wednesday, the markets are in the right mind-set to accept this change with
little real damage potential." While most observers expected the Fed to keep
its statement largely unchanged, few will be sorry to see the "considerable period"
language disappear. Trying Markets' Patience "The Fed's latest foray into
effective communication - the 'considerable period' phrasing - has been a less-than-spectacular
success, leaving markets confused, volatile and often disappointed, while sowing
deep dissatisfaction at the (Fed)," wrote Ethan Harris, chief U.S. economist at
Lehman Bros. The Fed also updated its assessment of the job market. In its
Dec. 9 statement, it had said "the labor market appears to be improving modestly."
Wednesday's statement said "hiring remains subdued," adding that "other indicators
suggest an improvement in the labor market." Harris expects that the jobless
rate would have to approach 5%, down from its current 5.7%, and core inflation
would have to approach 2% before the Fed will signal it's getting ready to raise
rates. While the economy surged in the second half of 2003, "it has a ways
to go before it starts to cut more meaningfully into slack" in the job market
and production capacity, said Josh Feinman, chief economist at Deutsche Asset
Management-Americas. "It's hard to see the Fed doing anything before summer,"
Feinman said. The bulk of the tightening needed to bring rates to a level that's
no longer accommodative will wait until 2005, he says. For the next couple
of quarters the economy should remain in the "sweet spot" of the business cycle,
when growth surges and inflation and labor costs remain muted due to slack left
over from the downturn, Feinman says. Those conditions, along with rapid productivity
gains, have been boosting business profits. But as productivity growth subsides
and labor costs start to rise, profit growth is likely to slow, he says. Surging
profits have led to a rebound in business investment. While rising at a healthy
clip, capital spending growth seems to have slowed in the fourth quarter from
the third quarter's blistering pace. Big-ticket orders to U.S. factories held
steady in December, the Commerce Department said Wednesday. Wall Street had expected
orders to rebound 2% after falling 2.3% in November. Capital goods orders,
one of the best indicators of capital spending, fell 0.4%, excluding defense and
aircraft orders. That followed November's 5.6% drop. But shipments of such
capital goods, a proxy for the business fixed investment component of GDP, rose
0.5% in December and at an 8.3% annualized rate in the fourth quarter from third-quarter
levels, noted Brian Wesbury, chief economist at Griffin, Kubik, Stephens &
Thompson. While the durable orders were disappointing, as long as the economy
begins to exhibit the solid job growth needed for a sustainable recovery, "the
shortfall in orders will be very temporary," wrote Stephen Gallagher, chief U.S.
economist at SG CIB. Continue with: | 
