The Hindu Business Line : Fed's wordcraft roils markets

A rate rise still looks distant given the inflation - friendly data and a lack of job creation. In the end, the word substitution may turn out to be no more than mere semantics.

AS it turned out, the Federal Open Markets Committee of the US Federal Reserve dropped the phrase "considerable period" from its post-meeting statement issued last Wednesday. The new buzzword is "patient". The Fed said it could afford to be so in "removing its policy accommodation".

Markets went into a tizzy. The 10-year treasury yields shot up 15 bps and the 2-year rose close to 25 bps. The stock market also took the omission of the phrase badly and fell about 100 points.

Does this mean a substantive change in Fed policy? Economic data have been robust. Fourth quarter GDP, although below the widely expected 5 per cent, was still a healthy 4 per cent. The manufacturing index of the Institute of Supply Management (ISM) came in at 63.6, again a level not seen for the best part of two decades. Housing remains a stellar performer.

Yet, there is entirely no sign of an increase in inflation, which remains surprisingly low, despite the dollar's steep descent and surging energy and commodity prices.

The CPI is muted, stuck in the 1-2 per cent range in the last year. The GDP deflator, reportedly the Fed Chairman, Alan Greenspan's preferred inflation barometer, is even better behaved. The plain and unvarnished truth is that there is simply no inflation on the horizon despite the strong economy - the second half of 2003 saw growth reaching an almost torrid 6 per cent.

The employment picture is, however, not reassuring. There was practically no addition to non-farm payroll in December. It is somewhat of a puzzle that job creation has far lagged the strength of the recovery, which will be on a little weak foundation, unless the unemployment rate heads down. The President, Mr Bush's re-election chances will be damaged unless the headline jobless number falls to 5 per cent levels from 5.7 per cent now.

There is no question that the replacement of "considerable period" by "patient" is a shift in the Fed's stance. The former wording gave the impression of interest rates being on hold for quite sometime to come. That is gone. Yet, from this, it is not a given that the Fed will move all that soon.

Indeed, a rate rise still looks distant given the inflation - friendly data and a lack of job creation. In the end, the word substitution may turn out to be no more than mere semantics.

Still, the risk of an early Fed reversal is likely to push up medium and short rates. But the passive behaviour of inflation will keep the steepness of the US yield curve alive and well for some time to come.

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