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Fed considers rate hikes on inflation fears Original Source Link: (May no longer be active)
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Fed Minutes Say Rate Too Low to Keep Inflation Stable (Update2)
Jan. 4 (Bloomberg) -- The Federal Reserve's Open Market Committee concluded interest rates were still too low ``to keep inflation stable'' and said rising prices may become a risk to growth, according to minutes of its Dec. 14 meeting.
``The current level of the real funds rate target remained below the level it most likely would need to reach to keep inflation stable and output at its potential,'' the minutes said.
Treasury securities and stocks declined. Some members were concerned about potential signs of ``excessive risk-taking'' amid low rates, citing credit spreads and increasing numbers of mergers and initial public offerings the minutes said. A weaker dollar, higher energy prices, diminishing competition in some industries and a possible slowdown in worker output per hour were among the forces that may drive prices higher, the minutes said.
Today's release is the first time the Fed has issued minutes with a three-week delay instead of six, giving investors more timely information on Fed deliberations before the next meeting. The Fed raised the benchmark overnight lending rate a quarter- point to 2.25 percent Dec. 14, the fifth increase since June.
``With the economic expansion more firmly entrenched, cost and price pressures were likely to become a clearer intermediate- term risk to sustained good economic performance absent further reduction of accommodation,'' according to the document released in Washington.
Market Reaction
Inflation erodes the value of a bond's fixed payments, and U.S. Treasury notes fell after the minutes were released. The 4 1/4 percent note maturing in November 2014 fell 9/16 point, pushing up the yield 7 basis points to 4.28 percent at 2:54 p.m. in New York.
The Dow Jones Industrial Average fell 102 points, or 1 percent, while the Standard & Poor's 500 Index declined about 15 points, or 1.2 percent. Higher interest rates also may slow the housing market, and shares of home builders including Toll Brothers Inc. and D.R. Horton Inc. declined.
``It's more hawkish than I've heard them in a long time,'' said Mark Spindel, who manages $13 billion including government securities for the International Finance Corp., the investment arm of the World Bank. ``There was a sense before that they might pause. I don't think there's that sense anymore.''
After the December meeting, the Fed repeated a plan to raise rates ``at a pace that is likely to be measured,'' language it used in every statement since May 4. The FOMC is expected to raise the rate to 2.5 percent again on Feb. 2, based on the median estimate in a Bloomberg News survey.
The FOMC will meet for two days, Feb. 1 and 2, to decide its next rate move and prepare Fed Chairman Alan Greenspan's semiannual testimony before Congress, which typically takes place in February and July.
Speculation in Markets
Fed officials raised concerns about excess speculation in asset markets, caused in part by an extended period of low rates. The rate has been raised from 1 percent in June, which was the lowest since 1958.
``Some participants believed that the prolonged period of policy accommodation had generated a significant degree of liquidity that might be contributing to signs of potentially excessive risk-taking in financial markets evidenced by quite narrow spreads, a pickup in initial public offerings, an upturn in mergers and acquisition activity, and anecdotal reports that speculative demands were becoming apparent in the market for single family homes and condominiums,'' the minutes said.
The language shows the Fed is concerned about speculation, said Paul McCulley, a managing director at Pacific Investment Management Co., which manages the world's largest bond fund.
``What today's minutes hint at is that before they declare they are finished, they need to see some blood in the streets in risk markets,'' McCulley said.
Current Account Deficit
Several members of the FOMC were concerned about global financial imbalances including the U.S. federal deficit and current account deficit. Some Fed officials said the chance that the federal deficit would be cut significantly were ``remote,'' the minutes showed.
``Regarding global imbalances and the current account deficit in the United States, a number of participants expressed doubt that such imbalances would be reduced in the near-term,'' the minutes said. Fed officials also said strengthening demand among U.S. trading partners was ``unlikely.''
The current account deficit, the broadest measure of trade because it includes income from investments and transfer payments, widened to a record $164.7 billion in the third quarter, or 5.6 percent of the nation's $11.8 trillion economy. The federal budget deficit was a record $412 billion for the fiscal year that ended in September.
Inflation
Wholesale prices rose 5 percent in the year ended in November, the biggest year-over-year increase since December 1990. Prices for intermediate goods rose 9.8 percent, the most since a 10.2 percent rise in the 12 months ended June 1981.
As commodity prices rise, manufacturing suppliers in many industries are asking for price increases from their customers, said James Meil, chief economist at Eaton Corp. the world's No. 2 maker of hydraulic equipment behind Parker Hannifin Corp.
``It's fair to say one of the drivers motivating Fed policy is the sensitivity to this and the need to restrain these expectations of price increases,'' Meil said in an interview from Cleveland.
Rising stock and home prices should underpin consumption, the FOMC minutes said. The U.S. added about 2.2 million jobs last year and the economy grew about 4.4 percent, based on median forecasts in Bloomberg News surveys.
Close to Potential
``A few participants also noted that uncertainty about the extent of resource slack in the economy was considerable and that it was quite possible that the economy could be operating close to potential, particularly if labor force participation rates did not turn up much while employment continued to register gains,'' the minutes said.
The FOMC voted unanimously Dec. 14 to start releasing minutes on a three-week delay, instead of waiting as they used to do until after the next meeting. In effect, the minutes have now become the FOMC's third official communication tool on interest rates, in addition to the one-page statement released when meetings conclude and Greenspan's semi-annual testimony.
The most recent minutes say the U.S. central bank had been experimenting earlier with ``procedural changes'' that would allow for accelerated release of the minutes. After a debate on Dec. 14, ``a clear consensus'' emerged on releasing the minutes earlier, the document says.
The minutes may become as important as the statement, analysts said.
`Step Toward Transparency'
``We view this as a significant step toward transparency,'' said Brian Sack, senior economist at Macroeconomic Advisers in St. Louis and a former economist at the Fed board's division of monetary affairs. Sack has researched effects of the central bank's communication tactics.
FOMC meeting statements are constrained because the entire committee has to agree on the language, generally during the course of a one-day meeting, Sack said.
``That leads to statements that are brief and formulaic,'' Sack said. ``The minutes are a much more effective communication tool because they can contain conditionality, nuances, and express disagreement on the committee.''
Research by Sack and former Fed Governor Laurence Meyer, now the head of Meyer's Monetary Policy Insights in Washington, shows the impact of 6-week-old meeting minutes on 2-year U.S. Treasury yields ranked third behind FOMC statements and Chairman Greenspan's testimony.
With the earlier release, the minutes are likely to generate ``larger market responses,'' Meyer and Sack concluded in a Dec. 16 research note.
Last Updated: January 4, 2005 15:01 EST
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