Fed holds the line on rates; But it changes its 'bias' to a pro-tightening stance; Inflation watch is on; Wall Street sends stocks on roller-coaster ride; Monetary policy


Federal Reserve policy-makers left a key interest rate unchanged yesterday, but said they were poised to raise rates again should the tight U.S. labor market ignite inflation -- a statement that startled investors and prompted many economists to predict that the central bank would raise rates at its Nov. 16 meeting.

Stocks were whipsawed by investors who had hoped the central bank was finished raising rates. After spiking higher by more than 100 points, the Dow Jones industrial average dived immediately after the 2: 12 p.m. Fed announcement -- descending as much as 124 points into minus territory -- before rebounding to close at 10,400.59, down 0.64 points.

And U.S. Treasury bonds incurred their largest loss in two months. The 30-year bond shed $12.19 for each $1,000 of face value, pushing yields from 6.08 percent up to 6.17 percent.

First Union Economics Group economist David Orr said that yesterday was proof again of the skill with which Fed Chairman Alan Greenspan manages the capital markets. That is critical with stocks so pricey that they may be vulnerable to a big sell-off, such as one that could be touched off by a surprise interest-rate increase.

"They're trying to tell the market: 'Don't count us out for a rate increase. We might not do anything. But we might decide to do something. And we don't want you to take us off your radar screen,' " Orr said.

The stock market remained calm in both June and August after the Fed announced quarter-point increases in the federal funds rate, largely because Greenspan had repeatedly telegraphed the central bank's intentions.

But the Fed chairman had said little in advance of yesterday's meeting of the policy-setting Federal Open Market Committee, which is why economists and other Fed-watchers felt confident the federal funds rate would hold steady at 5.25 percent.

Yet, that silence is why the Fed's adoption of a "tightening bias" initially spooked many investors.

It is the continued dearth of qualified workers that is forcing the central bank to adopt, and make known, its hawkish stance, because tight labor markets and low unemployment rates are usually inflationary. Companies have to pay more to fill openings, a jump in costs that is nearly always passed along in the form of higher sticker prices on products and bulked-up bills for services.

The efficiency that U.S. companies achieved this decade by cutting workers and installing big-ticket technology has kept inflation at bay, Greenspan and other central bankers say. Nevertheless, the Fed has to be particularly vigilant right now, the central bank said in a statement. "The growth of demand has continued to outpace that of supply, as evidenced by a decreasing pool of available workers willing to take jobs," the Fed said.

"In these circumstances, the Federal Open Market Committee (FOMC) will need to be especially alert in the months ahead to the potential for costs to increase significantly in excess of productivity in a manner that could contribute to inflation pressures and undermine the impressive performance of the economy."

While many economists, investors and consumers view Greenspan as the guardian of capitalism, some see him as a curmudgeon who wants to take the punch bowl from the party. But the Fed chief is not afraid of growth -- he just wants growth to continue at a pace that would not cause the painful boom-and-bust cycles of the past, said Merrill Lynch & Co. chief economist Bruce Steinberg. Steinberg said that is why the Fed will -- and probably should -- increase interest rates when the Greenspan-chaired FOMC next meets, in November. "That is my call," Steinberg said. "He'll raise rates in November."

As the most sensitive indicator of the direction of interest rates, the federal funds rate the central bank let stand yesterday is one tool used to tighten, or loosen, credit. Tighter credit slows growth by restricting consumer and corporate access to money.

To date, the U.S. economy has been incredibly reluctant to slow, growing at 3.9 percent in both 1997 and 1998 -- a pace previously believed to cause rampant inflation.

Spawned in April 1991, in December the expansion became the longest peacetime expansion in U.S. history.

According to the National Bureau of Economic Research, the only longer run of uninterrupted growth took place between 1961 and 1969 -- a stretch that coincided with the Vietnam War.

It can take anywhere from three to nine months for a rate increase to snake its way through an economy. That is why it is too early to say with certainty how even the increases of this past summer will affect growth, said First Union's Orr.

"With each step, one less person gets hired. With each step, one less house gets started. It has a cumulative effect," he said.

Pub Date: 10/06/99

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