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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.
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