Faced with mixed signals on growth and fresh evidence the economy is failing to create new jobs, Federal Reserve Chairman Alan Greenspan and his colleagues left a key short-term interest rate unchanged at a 46-year low Wednesday.
While the central bank gave no hint on when it might begin raising rates, it roiled financial markets with a new statement that eliminated a promise to leave rates low "for a considerable period." Long-term interest rates rose sharply after the statement was issued at 2:15 p.m. ET, and stock prices fell for a second straight session, with broad market indices ending the day down about 1.3 percent.
Meeting for the first time in the new year, the central bank left the overnight federal funds rate at 1 percent as expected, meaning a host of related consumer and business lending rates also will remain unchanged, including the prime rate.
In the statement issued after its two-day meeting, the Fed said that with inflation "quite low" and plenty of excess capacity in the economy, policy-makers "can be patient in removing its policy accommodation."
Several analysts called the new wording an incremental change from the "considerable period" language that had been included in every statement since August but had made some Fed governors uncomfortable, according to minutes of past meetings.
"As a practical matter they are saying the same thing," said Sung Won Sohn, chief economist at Wells Fargo. "They are just taking one small step at a time in the direction of tighter policy."
But many traders and investors apparently felt the new wording increased the odds of a rate hike this year, possibly as early as the June meeting of the policy-making Federal Open Market Committee.
Tony Crescenzi, chief bond market strategist at Miller Tabak & Co., said the new Fed wording means the central bank will raise rates in line with Greenspan's incremental approach to monetary policy.
"There are many big firms and many out there who believed the Fed would be on hold for all of this year, but this changes that," he said. "What the Fed said was, 'The odds are we will have to raise rates this year, but don’t worry.' I think it's a very good transition statement."
Other analysts disagreed strongly with this interpretation and said the reaction of financial markets reflects a drawback in the Fed's habit of modifying its policy statement slightly after every meeting. Prior to 2001 the Fed relied more on boilerplate language that was well understood by traders and analysts.
"They are trying to be transparent by giving a lot of nuanced message, but in reality they are just being confusing," said Ethan Harris, chief U.S. economist at Lehman Bros. "Every time they introduce a new set of language there is a debate over what it means."
Some of the confusion could be cleared up when Greenspan testifies to a House Committee Feb. 11, delivering his semiannual update on the economy and monetary policy.
Weak job growth
The economy enjoyed its best growth in nearly 20 years in the third quarter and carried that momentum forward into the fourth quarter. The latest wave of corporate earnings has shown the best growth in years, propelling major stock indices this week to their highest level in 31 months.
Yet the economy added a scant 1,000 jobs last month, far short of the 150,000 expected by many analysts. The Fed, in its statement, acknowledged the weak job growth but also noted that "other indicators suggest an improvement in the labor market."
The government reported Wednesday that orders for big-ticket durable goods were flat in December after falling in November, disappointing analysts and raising questions about the strength of the manufacturing economy. But such orders can be highly volatile from month to month, analysts said.
With little job growth and almost no inflation, nearly all major forecasters expect the central bank to stay on the sidelines at least until midyear.
But that is where the consensus ends. Roughly half the analysts contacted in recent surveys expect the Fed to begin raising rates by August, while the other half believe the Fed will leave short-term rates unchanged at current low levels well into 2005 — especially after last month’s disappointing employment figures.
“The economy has been giving off conflicting signals,” said Vince Boberski, senior economist at RBC Dain Rauscher. “Everybody has been digesting the data through the lens of last month’s employment report.”
Sohn said he does not expect the Fed to begin raising rates until early in 2005.
"They are still saying that until and unless we see significant and sustained growth in employment and probably a sustained increase in inflation they are not like to change the policy," he said. "I don’t think they will be pulling the trigger anytime soon."
Some of the confusion could be cleared up with a key employment report coming up Feb. 6, which will revise figures going back two years. Doug Duncan, chief economist for the Mortgage Bankers Association, said the revision is likely to show that employment has been growing more strongly than previous reports indicated, and that in turn will raise the odds for a Fed rate hike by August.
Complete text of Fed statement
The Federal Open Market Committee decided today to keep its target for the federal funds rate at 1 percent.
The Committee continues to believe that an accommodative stance of monetary policy, coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity. The evidence accumulated over the intermeeting period confirms that output is expanding briskly. Although new hiring remains subdued, other indicators suggest an improvement in the labor market. Increases in core consumer prices are muted and expected to remain low.
The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.
Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Ben S. Bernanke; Susan S. Bies; Roger W. Ferguson, Jr.; Edward M. Gramlich; Thomas M. Hoenig; Donald L. Kohn; Cathy E. Minehan; Mark W. Olson; Sandra Pianalto; and William Poole.