May 04, 2005|By James P. Miller | James P. Miller,CHICAGO TRIBUNE
The Federal Reserve angered traders and mystified markets yesterday by inexplicably forgetting to include a crucial phrase in its closely watched policy statement after it raised interest rates another quarter-point.
The government's blunder sent a wrong signal to investors about the Fed's view of inflation trends, and it wasn't corrected for nearly two hours. During that time, traders in the stock and bond markets laid down financial bets based on a Fed "policy shift" that turned out to be an illusion.
The Fed's policy statement "is probably the single most-read document in the largest economy in the world, and you're telling me that you can't get the thing right before it goes out?" fumed Barry L. Ritholtz, of the Maxim Group LLC, a New York brokerage. "That's astonishingly incompetent."
In implementing its eighth consecutive quarter-point rate increase, to 3 percent, the central bank's Federal Open Market Committee surprised nobody.
Later in the afternoon, however, the committee stunned economists and financial markets by issuing a correction to the text of its carefully worded - and intensely scrutinized - assessment of the health of the nation's economy.
The Fed said it had "inadvertently" omitted a sentence which, when reinserted, downplayed the Fed's concern about inflation's threat.
That disclosure, which came just as the markets were closing, caused the Dow to reverse course and rise 51 points, into positive territory, in the last five minutes of trading.
The government's slip-up came at a time when Fed statements may be receiving unusually close review. That's because the nation's economy has been flashing conflicting signals of late: recent data have been showing a significant slowdown in economic growth, even as inflation is making a comeback.
Fixing the former condition would suggest the Fed needs to maintain or even lower interest rates to stimulate the economy. But containing inflation would call for higher rates to put the brakes on an overheating economy.
After the economy went into a recessionary swoon in 2001, for example, Fed Chairman Alan Greenspan and the Federal Open Market Committee reduced rates sharply, to the lowest levels in four decades.
Only in mid-2004 did the Fed begin to ratchet up rates from their ultra-low levels. Through a methodical series of quarter-point increases, the committee has raised the federal funds rate - the interest banks charge each other on overnight loans - from 1 percent to 3 percent.
"Since the rate hike was considered a done deal," noted Joel Naroff of Naroff Economic Advisors, "most eyes were focused on the statement that accompanied the increase."
Unknown to investors, however, the statement was flawed.
As it has indicated routinely since beginning the cycle of rate increases in June, the Fed said yesterday that it thinks it can increase rates "at a pace that is likely to be measured."
In its earlier statements, the Fed has been careful to note that, "Longer-term inflation expectations remain well contained." When yesterday's statement didn't contain that reassurance, Fed-watchers interpreted the omission as a hint that Greenspan is growing more worried about inflation.
That message is crucial to mortgage lenders, bond traders and other business sectors that are rate sensitive. So, by late in the day, that downbeat interpretation had helped push the Dow down 46 points, and sent tremors through the bond market.
The fed policy-makers eventually issued a corrected policy statement that re-inserted the language. And in the final minutes of trading, the market responded by turning on a dime.
The Chicago Tribune is a Tribune Publishing newspaper.
