FED WATCH: Inflation Words May Be A Prelude To An End
By Michael S. Derby
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--The Federal Reserve may be getting the market ready
for the beginning of the end.
Comments and statements from the central bank and its officials have in
recent months repeatedly stressed that its key concern is that U.S. growth
levels have slowed too much, and that aggressive doses of interest rate cuts
are necessary to get the economy back on track. But more recently, Fed
officials have also begun slipping into their economic assessment statements
an acknowledgment of the risks of inflation.
In its statement accompanying last week's half percentage point cut in the
fed funds interest rate target to 4%, the Fed made mention of price
pressures for the first time in several months, adding the important caveat,
however, that "inflation is expected to remain contained."
Now, the ante has been raised again. On Thursday afternoon, markets were
rattled by the explicit utterance of the "I" word by Federal Reserve
Governor Larry Meyer.
In prepared comments for a speech in Scotland, Meyer reiterated the need for
the central bank to act forcefully to change weak economic circumstances,
but he included the following sentence: "Given that labor markets remain
tight, that inflation remains above the rate that I would find acceptable
over the longer run, and that core inflation has been edging higher,
attention must also be given to calibrating the easing to avoid overshooting
in the other direction in a way that ends up adding to price pressures as
growth strengthens."
For many Fed watchers, the inflation chatter makes little difference to the
passage of further rate cuts over the next few months that are generally
expected to amount to an additional quarter or a half percentage point of
monetary easing.
Instead, they said, the comments may serve as a subtle warning to the market
that the easing cycle is almost over, and that sometime next year the Fed
will have to again increase rates to keep a recovering economy from driving
up inflation.
"There have been some subtle hints lately that some Fed officials... are
starting to consider that the amount of tightening they've done is massive,
and they may be looking for a place to pause," said Jade Zelnick, head
economist with Greenwich Capital Markets in Greenwich, Conn.
Markets already appear to be looking for that pause, and they're also
betting the Fed will start raising rates next year as the economy begins to
rebound. Market participants say that Eurodollar futures contracts are
predicting that the Fed will tighten rates to somewhere around 4.75% and 5%
by the fall of next year.
"The Fed is in the process of pushing the funds rate down to unsustainably
low levels," said Dana Johnson, an economist at Banc One Capital Markets in
New York. Given current economic conditions, "that's not going to prevent
them from easing now," but it will require rates to move higher sometime
next year, he said.
Central Banks, Core Missions
Some also see Fed official's references to inflation as a bone thrown to
those who fear that the central bank's effort to spur growth has come at the
expense of its commitment to keep prices contained.
Meyer and the Fed are "not trying to soften the market up for a slowdown in
the easing process, but to start addressing the rebound in inflation
expectations" that many people are currently entertaining, said Lou
Crandall, chief economist at Wrightson & Associates, in New York.
And in that light, the inflation comments don't have any real impact on
monetary policy - they simply serve to show that the Fed knows what balls
it's juggling, Crandall explained.
Fed Chairman Alan Greenspan is scheduled to address an economists' group in
New York Thursday evening. Market participants are uncertain what he'll talk
about, but few are looking for him to go much beyond the general outlook
laid out in the FOMC statement from last week.
-Michael S. Derby, Dow Jones Newswires; 201-938-4192;
michael.derby@dowjones.com
(END) DOW JONES NEWS 05-24-01
05:04 PM
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