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Fed stands pat on interest rates

The Federal Reserve left interest rates unchanged Tuesday and declined to make a statement on the balance of economic risks.  By Martin Wolk.
/ Source: msnbc.com

The Federal Reserve left interest rates unchanged Tuesday and declined to comment on the balance of economic risks, citing “unusually large uncertainties” clouding the outlook in the days before a likely war in Iraq.

The decision by Fed Chairman Alan Greenspan and his colleagues to stay mum on the economic outlook just ahead of a likely war left many on Wall Street slack-jawed with surprise. While only a few prominent economists expected a rate cut, the vast majority thought the central bank at least would acknowledge growing economic risks, paving the way for a possible rate cut even before the next scheduled meeting of policy-makers May 6.

Instead the Fed issued what one financial market economist described as a “confusing” statement, saying the economic outlook is so uncertain its rate-setting Federal Open Market Committee “does not believe it can usefully characterize the current balance of risks.” The Fed reiterated that its 12 rate cuts over the past two years should be sufficient to improve the economy “over time.” But at the same time it said “heightened surveillance is particularly informative” in current conditions, a comment that some interpreted to mean that that the possibility of another rate cut before May 6 is under consideration.

“Basically the Fed decided to take a pass,” said Steve Stanley, senior market economist for RBS Greenwich Capital. He said central bankers intended to signal to financial markets that they are in no hurry to ease and might wait for another month or two of economic data before deciding on any rate move.

Stocks end higher
Financial markets were relatively subdued after the Fed’s announcement, with stocks ending higher for a fifth straight session. Many traders were said to be unwinding safe-haven positions in anticipation of a relatively quick U.S. military victory.

The deterioration of data over the past six weeks has left economists sharply divided. Many believe the latest economic slowdown largely reflects temporary factors including severe winter weather and uncertainty over war that has restrained business investing or hiring. Others contend the economy is suffering from long-term imbalances and is unlikely to snap back quickly even if the war goes well for the United States and its military allies.

In its statement Tuesday, the Fed appeared to side with those who blame poor economy largely on the run-up to war, saying recent disappointing data “owe importantly to oil price premiums and other aspects of geopolitical uncertainties.”

Still, many economists predict that by midyear at the latest the Fed will have to cut its benchmark federal funds rate again from its current 1.25 percent, the lowest in more than 40 years.

“I’m not a big fan of the theory that the recent weakness is all due to war fears,” said David Rosenberg, chief economist of Merrill Lynch. He had predicted the Fed would cut rates Tuesday but nearly “fell out of my chair” when the central bank declined to change its balance of risks statement, which officially has been neutral since the last rate cut Nov. 6.

He said at least eight of the past 11 major indicators have come in below expectations, “and those expectations weren’t that great to begin with.” Yet the Fed acknowledged only that labor market indicators have been disappointing, saying that overall recent economic data have been “mixed.”

“The last piece of good news we got was the revision of fourth-quarter GDP,” said Vince Boberski, senior economist for RBC Dain Rauscher. “Since then the numbers have been almost uniformly poor.”

Boberski correctly predicted the Fed would aim to stay out of the limelight with the clock winding down to an expected U.S.-led invasion of Iraq.

“I think if the war were not imminent that the Fed at the very least would have shifted their stance toward cutting and might have even gone ahead and cut 50 basis points,” he said. “But I have to think policy-makers want to stay out of the headlines as much as they can.”

Nevertheless he acknowledged that Fed officials obviously had a tough time coming up with a statement Tuesday, given the high likelihood of a war within days.

“There is so much uncertainty right now,” Boberski said. “Certainly the Fed can shift their bias or cut rates in between meetings. But I think it would behoove them to wait and see how things play out in the next week or two weeks. ”

Another rate cut would lower the cost of short-term borrowing for businesses but likely would have limited effect for consumers because many adjustable-rate loans such as credit cards are already at contractual lows. Mortgage rates also have fallen sharply in recent months to their lowest levels in 40 years or more, leading many analysts to predict they are unlikely to fall much further.

But a rate cut could provide a psychological boost and would send a signal that the Fed stands ready to supply as much liquidity as the financial markets require.

Fed's full statement
The Fed issued the following statement following its meeting Tuesday:

“The Federal Open Market Committee decided today to keep its target for the federal funds rate unchanged at 1-1/4 percent.

While incoming economic data since the January meeting have been mixed, recent labor market indicators have proven disappointing. However, the hesitancy of the economic expansion appears to owe importantly to oil price premiums and other aspects of geopolitical uncertainties. The Committee believes that as those uncertainties lift, as most analysts expect, the accommodative stance of monetary policy, coupled with ongoing growth in productivity, will provide support to economic activity sufficient to engender an improving economic climate over time.

In light of the unusually large uncertainties clouding the geopolitical situation in the short run and their apparent effects on economic decision making, the Committee does not believe it can usefully characterize the current balance of risks with respect to the prospects for its long-run goals of price stability and sustainable economic growth. Rather, the Committee decided to refrain from making that determination until some of those uncertainties abate. In the current circumstances, heightened surveillance is particularly informative.

Voting for the FOMC monetary policy action were Alan Greenspan, Chairman; William J. McDonough, Vice Chairman; Ben S. Bernanke; Susan S. Bies; J. Alfred Broaddus, Jr.; Roger W. Ferguson, Jr.; Edward M. Gramlich; Jack Guynn; Donald L. Kohn; Michael H. Moskow; Mark W. Olson, and Robert T. Parry.”