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Wording Change Scares Investors, but Economists See No Policy Shift
By
Nell Henderson
Washington Post Staff Writer
Thursday, January 29,
2004; Page E01 Federal Reserve officials left a key short-term interest
rate unchanged yesterday, but financial markets swooned after the central bank
used slightly different language to signal it will continue to keep rates very
low for a while.
Policymakers said in a statement after their meeting yesterday that they "can
be patient" in holding rates low, dropping their previous commitment to do so
"for a considerable period." Stocks tumbled after the language was released, as
many investors apparently worried that the central bank might raise rates sooner
than they expected. The new phrase picked up words used repeatedly by Fed
Chairman Alan Greenspan in recent months, leading several economists to conclude
the central bank's message remains the same: Although the economy is clearly expanding,
Fed policymakers will not raise rates until they see signs the recovery is on
more solid footing -- specifically that businesses are using up more of their
excess capacity, that the job market is brightening significantly and that inflation
is not falling. The Fed statement "doesn't mean they are going to hike
rates any time soon," said Ethan S. Harris, chief U.S. economist with Lehman Brothers
Inc., who thinks a Fed rate increase would come this summer at the earliest, and
probably not until next year. "The Fed is still waiting for healing and is focused
on getting growth going." He added, however, that the change in phrasing
"does look like they've taken another baby step" toward a rate increase. The
central bank's top policymaking group, the Federal Open Market Committee, first
lowered its target for overnight rates to 1 percent, a 45-year low, in June. It
has kept it there since then to help hold down borrowing costs on business and
household loans, stimulating continued spending and economic growth. Investors
and economists disagree over how long Fed officials can maintain rates so low
in an economy that is widely forecast to grow more than 4 percent next year. Some
economists argue that the Fed is falling behind, and should have started raising
rates already to avoid overheating the economy. Others worry that even a slight
increase in the Fed's target will cause other interest rates to jump, possibly
choking off the recovery and hopes for more meaningful job creation. Fed
policymakers first said after their August meeting that they could maintain low
rates "for a considerable period," and had repeated that phrase after each meeting
since then. But some officials have been uncomfortable with wording that could
be taken too literally to imply a specific time frame, while others worried that
markets would overreact when the language was eventually dropped to make way for
rate increases. Fed officials have worked to make clear that the length
of the period will depend on how the recovery unfolds. On that basis, they have
indicated, the period is likely to extend for several months, and perhaps more
than a year. They believed they had prepared the markets for the day they would
drop the phrase. But stock prices fell yesterday as many investors worried
that higher interest rates will slow economic growth. The Dow Jones industrial
average fell 141.55 points, or 1.3 percent, while the broader Standard & Poor's
500-stock index dropped 15.57 points, or 1.4 percent. "The Fed has blindsided
the markets -- again, take an F for communications skills -- by dropping the 'considerable
period' clause," wrote Ian Shepherdson, chief U.S. economist with High Frequency
Economics Ltd. of Valhalla, N.Y., in a note to clients yesterday. "The Fed is
slowly, and awkwardly, edging towards" a rate increase, he said. Fed officials
were so concerned in October about the markets' misunderstanding their intentions
that they formed a working group to study ways to improve communication. On Tuesday,
the group presented its findings to all 19 FOMC members, who had "productive discussions
of a full range of communications issues" but made "no announcement of a specific
change" in policy, a spokeswoman said yesterday. The working group had
finished its task, but the committee "maintains an ongoing interest in considering
issues of effective communication with the public," the spokeswoman said. James
Glassman, senior economist at J.P. Morgan Securities Inc., said that yesterday
was a good time to drop the "considerable period" language because the recent
economic data have proved so disappointing that it should be clear the Fed is
not going to raise rates soon. Job creation remains feeble. Inflation by
some measures is falling. And orders for durable goods, manufactured items expected
to last several years, were flat last month after falling in November, the Commerce
Department reported yesterday. After excluding volatile orders for transportation
equipment, durable goods orders fell 0.7 percent, the second monthly decline in
a row in the category. Glassman said the economic news "is not taking one
closer to a Fed tightening, it's pushing it farther out." Continue with: | 
