Don't Misread the Fed's "Bias" Statement


By Rich Miller It's that time again. The financial markets are working themselves into a tizzy over the Federal Reserve's next move. No one expects Chairman Alan Greenspan and his fellow policymakers to change interest rates at their meeting on Mar. 19. Instead, investors are in a lather over whether the Federal Open Market Committee (FOMC) will change what the markets still call the Fed's "bias statement" -- but which the central bank now refers to as its "assessment of the risks to satisfactory economic performance."

Since December, 2000, the Fed hasn't wavered: It has declared that a weak economy was a greater danger to satisfactory economic performance than the threat of heightened inflation. Now, with the economy rebounding smartly from last year's mini-recession, the markets are worried the Fed will shift today to a more neutral, balanced assessment of the risks.

Will this be a prelude to an increase in interest rates at its next meeting on May 7? "The FOMC policy statement has turned into a high-stakes event for the market -- despite the fact that there is virtually no doubt that the Fed will leave [interest rates] unchanged," says Louis Crandall, chief economist at consultants R.H. Wrightson & Associates.

LONG-TERM GUIDE. Investors should just chill out. Even if the Fed does shift its assessment of the economic risks, that doesn't mean that an interest rate increase is in the offing anytime soon. Greenspan wants to make sure the recovery sticks (see BW, 3/25/02, "Why the Fed May Be Slow to Tighten"). What's more, breathless Fed watchers are forgetting something: The economic-risks statement isn't the bias statement of old, and it isn't intended to be a signal of an imminent policy change. Instead, it's meant to be a longer-term guide to where the Fed thinks the economy may be heading. Smart investors will read it that way.

The Fed adopted the risk-statement policy at the start of 2000, primarily to get away from the impression that it was trying to signal the markets about near-term policy shifts. Prior to that, Greenspan & Co. regularly announced what it called its "policy bias" -- whether it was leaning toward raising or lower interest rates, or keeping them unchanged.

The problem, in the Fed's eyes, was that changes in its old policy bias frequently led to an exaggerated response in the financial markets. Once the bias was announced, investors reacted immediately as if a policy change was a fait accompli, pushing market interest rates up or down in the process.

NO QUICK SHIFT. To get away from that, the central bank modified its disclosure procedures by adopting the balance of risks statement. In a Jan. 19, 2000, press release announcing the change, the Fed said its view of the risks "would not necessarily trigger...a subsequent policy move." It also said its assessment of the risks was intended to cover "a length of time extending beyond the next FOMC meeting." In plain English: Investors would be wrong to read the Fed's statements as signaling an imminent shift in policy.

Yes, there's a good chance that the Fed will raise interest rates sometime later this year. After all, the overnight interbank federal funds rate that the central bank controls is at its lowest level in more than four decades. But given all the uncertainties still facing the economy -- from high consumer debt to paltry corporate profits -- Greenspan & Co. isn't in any rush to tighten credit. And that's true even if the Fed says on Mar. 19 that it's no longer all that worried about weakness in the economy. Miller covers the Fed from BusinessWeek's Washington bureau


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