Economists Call Market Turmoil Unwarranted
Over the past two weeks, longer-term interest rates have soared and plummeted as jittery investors reacted to recent signs of strong economic growth and a fear that the Federal Reserve might soon begin to raise its extraordinarily low target for overnight rates.
Those fears were fed first by comments by two Fed officials that were taken as a signal that rates will be raised. Then a statement by Treasury Secretary John W. Snow in a newspaper interview was interpreted by some as indicating that the Bush administration wanted the Fed to boost rates.
But the Treasury said Snow's remarks were misinterpreted, and a close reading of the comments by the Fed officials indicated they were making academic points rather than sending signals.
When Fed officials meet Tuesday to discuss the state of the economy and set a short-term course for interest rates, they are extremely unlikely to make any change in their 1 percent overnight rate target. Moreover, they are also likely to release a statement similar to the one they issued after their September meeting saying they are more concerned about the possibility that the already low inflation rate will fall further than that economic growth will be too strong.
At this point, Fed officials are not contemplating raising rates. Although the economy is growing more rapidly, the unemployment rate remains above 6 percent and many economists believe there is little reason to expect joblessness to decline rapidly. In these circumstances, the Fed is likely to leave rates low until there is unmistakable evidence that significant, sustainable job growth is occurring. Some analysts think that may not happen until the second half of next year, or even early 2005.
Many investors, however, bet last week that the Fed might move to raise rates no later than March.
They were spooked, in part, by forecasters' predictions that the economy grew at more than a 6 percent annual rate in the July-September period. (The actual figure will be reported by the Commerce Department next Thursday.) The same forecasters also expect growth to drop back to around a 4 percent annual rate in the current quarter and to continue at around that pace during 2004. A number of Fed officials, including Governor Ben S. Bernanke, have said they find such a forecast plausible.
In the past, such growth rates might well have caused the Fed to begin to raise their target, which on an inflation-adjusted basis is below zero. But the current circumstances are exceptional. In the third quarter, that strong growth in the production of goods and services was matched by a productivity surge so great that the number of hours worked actually declined.
In other words, very strong economic growth did not put a dent in the nation's 6.1 percent jobless rate. And while many economists and policymakers expect productivity gains to moderate along with growth in coming quarters, it is not clear that a 4 percent growth rate would be strong enough to cause unemployment to decline.
Many Fed officials pay close attention to a concept known as the output gap. In simple terms, that is the difference between what the U.S. economy is producing and what it could be producing at full employment, the lowest unemployment rate that can be sustained without causing inflation to accelerate. While there is no agreement on what that rate is, many economists believe it is in the neighborhood of 5 percent. In theory, so long as the jobless rate is higher than the full employment level, there will be some downward pressure on inflation.
"The general sense I have is that people are a little bit too focused on growth" in speculating about what the Fed might do, said William C. Dudley, chief economist at Goldman, Sachs & Co. "What matters is not so much the growth rate but how many jobs that growth creates. I think the necessary conditions for the Fed to consider tightening are enough growth to generate 150,000 to 200,000 jobs a month for several months, and some sense that the inflation rate is no longer declining."
Since neither of those conditions exists now, Dudley added, "we think the Fed won't change the [meeting] statement in any meaningful way next week except to acknowledge that the economy is stronger."
So far this year, the core consumer price inflation measure most closely watched by the Fed has increased at an annual rate of just over 1 percent .
In its statement last month, the Fed's top policymaking group, the Federal Open Market Committee, said that "on balance, the risk of inflation becoming undesirably low is likely to be the predominant concern for the foreseeable future. In these circumstances, the committee believes that policy accommodation can be maintained for a considerable period."
A lot of the investor uneasiness centers on what the Fed regards as "a considerable period."
One of the comments that upset the market last week came from Robert T. Parry, president of the San Francisco Federal Reserve Bank, who said in response to a question after a speech, "I think accommodative policy is not necessarily a time when interest rates are just kept flat." Some investors and analysts concluded that Parry had decided that "a considerable period" was fairly short and that he wanted rates to begin to rise relatively soon.
But in his speech, Parry stressed a completely different view: "There's less concern about surprises that could push the inflation rate up and more concern about surprises that could push the inflation rate lower, possibly even leading to deflation."
Nevertheless, shortly after news services reported his answer about accommodative policy, the prices of futures contracts for overnight interest rates showed investors had decided that the Fed would begin to raise rates no later than March.
M. Cary Leahey, an economist at Deutsche Bank Securities Inc. in New York, disagreed.
"One needs to remember that the Fed is going to move slowly in raising rates for fear that tightening would derail what may finally be a job-creating expansion," Leahey said. "So, until the Fed can be sure [jobs are being created] -- and it seems unlikely that the evidence will be totally compelling by the first quarter of 2004 -- the Fed is going to be cautious. With inflation low, the Fed has the ability to be patient, even if the markets are not."
Over the past two weeks, longer-term interest rates have soared and plummeted as jittery investors reacted to recent signs of strong economic growth and a fear that the Federal Reserve might soon begin to raise its extraordinarily low target for overnight rates.
Those fears were fed first by comments by two Fed officials that were taken as a signal that rates will be raised. Then a statement by Treasury Secretary John W. Snow in a newspaper interview was interpreted by some as indicating that the Bush administration wanted the Fed to boost rates.
But the Treasury said Snow's remarks were misinterpreted, and a close reading of the comments by the Fed officials indicated they were making academic points rather than sending signals.
When Fed officials meet Tuesday to discuss the state of the economy and set a short-term course for interest rates, they are extremely unlikely to make any change in their 1 percent overnight rate target. Moreover, they are also likely to release a statement similar to the one they issued after their September meeting saying they are more concerned about the possibility that the already low inflation rate will fall further than that economic growth will be too strong.
At this point, Fed officials are not contemplating raising rates. Although the economy is growing more rapidly, the unemployment rate remains above 6 percent and many economists believe there is little reason to expect joblessness to decline rapidly. In these circumstances, the Fed is likely to leave rates low until there is unmistakable evidence that significant, sustainable job growth is occurring. Some analysts think that may not happen until the second half of next year, or even early 2005.
Many investors, however, bet last week that the Fed might move to raise rates no later than March.
They were spooked, in part, by forecasters' predictions that the economy grew at more than a 6 percent annual rate in the July-September period. (The actual figure will be reported by the Commerce Department next Thursday.) The same forecasters also expect growth to drop back to around a 4 percent annual rate in the current quarter and to continue at around that pace during 2004. A number of Fed officials, including Governor Ben S. Bernanke, have said they find such a forecast plausible.
In the past, such growth rates might well have caused the Fed to begin to raise their target, which on an inflation-adjusted basis is below zero. But the current circumstances are exceptional. In the third quarter, that strong growth in the production of goods and services was matched by a productivity surge so great that the number of hours worked actually declined.
In other words, very strong economic growth did not put a dent in the nation's 6.1 percent jobless rate. And while many economists and policymakers expect productivity gains to moderate along with growth in coming quarters, it is not clear that a 4 percent growth rate would be strong enough to cause unemployment to decline.
Many Fed officials pay close attention to a concept known as the output gap. In simple terms, that is the difference between what the U.S. economy is producing and what it could be producing at full employment, the lowest unemployment rate that can be sustained without causing inflation to accelerate. While there is no agreement on what that rate is, many economists believe it is in the neighborhood of 5 percent. In theory, so long as the jobless rate is higher than the full employment level, there will be some downward pressure on inflation.
"The general sense I have is that people are a little bit too focused on growth" in speculating about what the Fed might do, said William C. Dudley, chief economist at Goldman, Sachs & Co. "What matters is not so much the growth rate but how many jobs that growth creates. I think the necessary conditions for the Fed to consider tightening are enough growth to generate 150,000 to 200,000 jobs a month for several months, and some sense that the inflation rate is no longer declining."
Since neither of those conditions exists now, Dudley added, "we think the Fed won't change the [meeting] statement in any meaningful way next week except to acknowledge that the economy is stronger."
So far this year, the core consumer price inflation measure most closely watched by the Fed has increased at an annual rate of just over 1 percent .
In its statement last month, the Fed's top policymaking group, the Federal Open Market Committee, said that "on balance, the risk of inflation becoming undesirably low is likely to be the predominant concern for the foreseeable future. In these circumstances, the committee believes that policy accommodation can be maintained for a considerable period."
A lot of the investor uneasiness centers on what the Fed regards as "a considerable period."
One of the comments that upset the market last week came from Robert T. Parry, president of the San Francisco Federal Reserve Bank, who said in response to a question after a speech, "I think accommodative policy is not necessarily a time when interest rates are just kept flat." Some investors and analysts concluded that Parry had decided that "a considerable period" was fairly short and that he wanted rates to begin to rise relatively soon.
But in his speech, Parry stressed a completely different view: "There's less concern about surprises that could push the inflation rate up and more concern about surprises that could push the inflation rate lower, possibly even leading to deflation."
Nevertheless, shortly after news services reported his answer about accommodative policy, the prices of futures contracts for overnight interest rates showed investors had decided that the Fed would begin to raise rates no later than March.
M. Cary Leahey, an economist at Deutsche Bank Securities Inc. in New York, disagreed.
"One needs to remember that the Fed is going to move slowly in raising rates for fear that tightening would derail what may finally be a job-creating expansion," Leahey said. "So, until the Fed can be sure [jobs are being created] -- and it seems unlikely that the evidence will be totally compelling by the first quarter of 2004 -- the Fed is going to be cautious. With inflation low, the Fed has the ability to be patient, even if the markets are not."
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