Fed holds on rates but shifts outlook
Markets swoon as bank hints increases could come sooner than later
By Robert Gavin, Globe Staff, 1/29/2004
A subtle shift in the Federal Reserve's outlook on interest rates yesterday sent financial markets reeling and mortgage rates jumping.
Fed policy makers voted to hold the key short-term interest rate at the 46-year low of 1 percent. But instead of pledging -- as they have since August -- to keep interest rates low for a "considerable period," they promised only to be "patient" before raising rates. Financial markets seized that change as evidence the central bank would boost rates sooner rather than later.
The Dow Jones industrial average plunged 141.55 points, or 1.3 percent, to 10,468.37. Bonds sold off, pushing the yield of the benchmark 10-year US treasury, which moves in the opposite direction of price, to 4.19 percent from 4.08 percent Tuesday. Mortgage rates, which are tied to long-term bond rates, quickly followed.
In a matter of hours, rates rose an eighth of a point for a 30-year fixed-rate mortgage and a quarter-point for a common adjustable-rate mortgage, according to the Countrywide Home Loans office in Burlington.
"As soon as the bond market sold off, there was an instantaneous rise in mortgage rates," said Bard Conn, Countrywide's area sales manager.
Mortgage rates have been falling in recent weeks as bond markets bet that continued weakness in the economy -- particularly job markets -- would lead the Fed to hold the federal funds rate at 1 percent indefinitely. Since hitting a US average of 6.44 percent in early September, the rate for a 30-year fixed mortgage has declined steadily, dipping to 5.64 percent last week, according to Freddie Mac, the government-created mortgage company.
But the Fed signaled yesterday that it not only sees the recovery continuing to gain steam, but labor markets improving.
Analysts said the change in language indicates the Fed is beginning to give itself room to raise rates. The Fed raises interest rates when it believes the economy is growing so fast that it could reignite inflation.
Most economists don't expect the Fed to begin boosting rates until summer at the earliest, and even then, they project the benchmark rate will remain below 2 percent -- also a historically low rate -- by year's end.
But the shift in the Fed's outlook caught financial markets by surprise, particularly after economic data released earlier yesterday was unexpectedly weak.
Orders for durable goods, expensive items expected to last three or more years, were flat in December, following a 2.3 percent drop in November, the Commerce Department reported. New home sales fell 5.1 percent in December.
The Fed statement "threw a bit of a curve," said Stuart Hoffman, chief economist at PNC Financial Services Group in Pittsburgh. "The Fed's open-ended commitment to a rate of 1 percent is over. It's not imminent that they are going to raise rates, but they are thinking about it."
Economists agreed that markets had perhaps engaged in wishful thinking about how long the Fed could hold pat. After all, they noted, the economy grew at a sizzling 8.2 percent in the third quarter of last year, and it is expected to have grown at a strong, albeit slower pace, in the fourth quarter.
The Commerce Department releases its first estimate of fourth quarter economic growth tomorrow.
Moreover, analysts added, the Fed even said it sees signs that the labor market is improving, despite weak hiring in December. Other indicators, including a steady decline in first-time claims for unemployment benefits, have pointed to a brightening outlook for jobs.
Ultimately, analysts stressed, the timing of an interest rate increase will depend on how quickly job markets improve. The longer it takes for the economy to start creating payroll jobs at a solid pace -- it added a paltry 1,000 in December -- the longer it will take for the Fed is to boost rates, they said.
"It's all contingent on the job market," said Wayne Ayers, the chief economist at FleetBoston Financial Corp. in Boston.
Robert Gavin can be reached at rgavin@globe.com.
boston.com
© Copyright 2004 Globe Newspaper Company. |
