The hourly XAU signals really got whipsawed today....
It's amazing what a change or two in the Fed's choice of verbiage will do:
Fed Holds Steady on Rates, but New Message Jolts Markets
By EDMUND L. ANDREWS
Published: January 28, 2004
WASHINGTON, Jan. 28 — The Federal Reserve left short-term interest rates at just 1 percent today, the lowest level since 1958, but it jolted markets by retreating from its open-ended pledge to keep rates low for "a considerable period.'
Though subtle, the Fed's change in language after its two-day policy meeting caught economists by surprise and it offered the clearest signal yet that the era of rock-bottom interest rates may be drawing to an end.
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The Fed's announcement shook up the financial markets. Prices of Treasury securities dropped sharply immediately afterwards, pushing up interest rates, though prices recovered slightly as investors began to parse the Fed's language in greater detail. The dollar surged against the euro and the Japanese yen. And the leading stock market indexes fell more than 1 percent.
A close reading of the Federal Reserve's statement suggested that the Fed's chairman, Alan Greenspan, remains unlikely to push for higher interest rates for several more months. As it has before, the central bank's Federal Open Market Committee reiterated its view that inflation remains very low and that the economy still exhibits a considerable amount of "slack," in the form of relatively high unemployment and large amounts of unused factory capacity.
"With inflation quite low and resource use slack, the committee believes that it can be patient in removing its policy accommodation," the Fed said in its statement after the meeting.
The distinction between keeping rates low for a "considerable period" and being "patient" is in many ways a nuance, but analysts said it is still very significant, given the enormous attention that markets pay to every word in the Fed's policy statements.
Analysts have been fixated for months on whether the Fed would continue to promise low rates for "a considerable period," and investors had increasingly become convinced that the Fed might not tighten its grip on the economy until early next year.
Michael Prell, a former head of research at the Fed, said Mr. Greenspan knew full well he was sending a signal to the markets.
"Chairman Greenspan does not make changes unless he thinks there is good reason to do so," Mr. Prell said. "Even though changing from the words `patient' to a :considerable period' might sound like a superficial difference, they must have thought this would communicate news to the market place."
Robert Di Clemente, a senior economist at Citigroup, said the Fed had caught investors "flat-footed" with its change in emphasis. Ian Shepherdson, an economist at High Frequency Economics, said the Fed had "once again blindsided the markets" but done so with an ambiguous statement that could be read in several different ways.
The bond market was especially jolted by the Fed's shift in its language. The price of the Treasury's benchmark 10-year note initially fell more than one and a half points in price. Late this afternoon, the note was down 29/32 of a point in price, pushing its yield, which moves in the opposite direction, up to 4.19 percent, from 4.08 percent late Tuesday.
The rise in interest rates bolstered the dollar, and the euro fell to $1.2481 this afternoon, from $1.2633.
Stocks fell steadily after the Fed's announcement, with the Standard & Poor's 500-stock index dropping 15.57 points, or 1.36 percent, to close at 1,128.48.
Today's announcement came at a time when almost all indicators point to very strong economic growth. On Friday, the federal government will release its first estimate of growth in the fourth quarter of last year, and the consensus prediction among forecasters is that the growth could be at or near an annual rate of 5 percent.
That would be slower than the third quarter of last year, but it is still a pace that is much faster than seemed likely just a few months ago.
In previous years, such widespread evidence of strong economic growth would have prompted the central bank to start tightening monetary policy by raising interest rates, but Fed officials have been focused on the sluggish pace of job creation and the very low rate of inflation.
After its policy-setting meeting last month, the Federal Open Market Committee created a buzz in the financial markets by declaring that the chances of an "unwelcome fall in inflation" had diminished and were almost equal to the risks of a rise in prices. That suggested the central bank was preparing the way for rate increases in the future, but Fed officials have made it clear since then that they still view inflation as almost non-existent and that they want to see a greater decline in unemployment.
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In the parlance of Alan Greenspan, the Fed's chairman, the central bank remains worried about "slack" in both the job market and industrial capacity. Job creation essentially came to a halt in December, according to the Department of Labor, which raised new doubts about the prospects for a significant drop in unemployment from its current level of 5.7 percent.
Economists inside and outside the Fed were also surprised when the government reported that consumer prices climbed at an annual rate of barely 1 percent in December. Although Mr. Greenspan has refused to embrace any explicit targets for an acceptable rate of inflation, several Fed governors have suggested that they are uncomfortable with "core inflation" — excluding the volatile prices for food and energy — that is below 1 percent.
"The rate of inflation is extremely low, arguably lower than they would like to see it," said Joshua Feinman, chief economist at Deutsche Asset Management in New York. "Combined with the notion that the economy still has some degree of slack in the labor and capital markets, that makes them a little uncomfortable."
The Fed has kept the federal funds rate for overnight loans at 1 percent ever since last summer. At the time, the economy still seemed to be swooning from uncertainty associated with the war in Iraq and continued reluctance among business executives to invest in new equipment or hire additional workers.
But the economy surged last summer, expanding at an astonishing annual rate of 8.2 percent in the third quarter — the fastest pace in 20 years. Still, the surge was fueled in large measure by last year's big tax-cutting package, and it remained unclear whether the growth would continue once the impact of the extra cash in people's pockets began to fade this year.
Economic growth now appears to have remained very strong during the last three months of 2003, and economists have raised their estimates for growth through the end of this year to about 4.6 percent.
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