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What It'll Take to Move the Fed

By Kevin Harris The policy outcome at the Jan. 27-28 meeting of the Federal Open Market Committee, the Federal Reserve's rate-setting arm, isn't in question. The Fed's interest rate target of 1.25% won't change.

In the runup to the meeting, a sudden quiet has followed an intense period of policy chatter by Fed officials. We at Informa Global Markets take that as a sign that the signals from the current round of "Fedspeak" have been accurately received by investors and financial markets. We believe no rate hike will occur in the first half of this year, with only modest odds of any such action in the second half.

REASONS OF PROPRIETY. Knowing that, it makes the language of the Fed's widely watched post-meeting policy statement (scheduled for release at 2:15 p.m. ET Jan. 28) a bit less critical than usual. Concern isn't as high that the Fed will soon abandon its "considerable period" phrase pertaining to how long it will maintain its accommodative policy. Fed Governor Ben Bernanke clearly laid out the policy prospects in a Jan. 4 speech. He said accommodation remains justified by "the current very low level of inflation and by the productivity gains and the weakness in the labor market, both of which suggest that inflation is likely to remain subdued."

Even if the Fed does abandon the phrase, most observers will recognize that it was for reasons of propriety (a number of board members thought the phrase should never have been used in the first place) rather than because the policy outlook has changed.

One virtue in Bernanke's commitment to clarity (not that he's alone) is that the markets now have a better idea of what it'll take to move the Fed. Until inflation rises, jobs begin growing, or productivity gains start slipping (most likely some combination of the three), Fed policy can remain accommodative. For now, core inflation (which doesn't include volatile food and energy prices) is, by a number of measures, still cooling, so no reason exists for the inflation-risk bias to return to neutral.

SIGNALS ON COMMUNICATION. Turning to another hot topic in policy circles, we doubt that Greenspan & Co. will mention the U.S. dollar's decline vs. other major currencies in the Jan. 28 statement. But even if Fed touches upon the subject, it seems quite unlikely that it'll represent a "jawboning" effort by the central bank to strengthen the U.S. currency.

But more is going on at next week's meeting than at other recent policy get-togethers. The usual issues include the post-meeting press release, which lays out the Fed's current policy outlook, as well as preparation for Fed Chairman Alan Greenspan's semiannual monetary-policy testimony before Congress on Feb. 11 and 12. Fed Vice-Chairman Roger Ferguson will also present the thinking of the Fed's in-house panel on communication, an effort to find ways to refine the Fed's message to the public. This has the potential to change the public face of FOMC meetings substantially.

One thing investors won't learn about until Greenspan presents his congressional testimony is the Fed's new full-year economic outlook. That will come on Feb. 11 with the release of the "central tendencies" forecasts for key measures such as growth, unemployment, and inflation. The Fed's view on the economy's current direction will be among the more important aspects of next week's meeting, however, as it will establish expectations regarding short-term policy leanings.

THE MARKET'S BENCHMARK. The combination of forecasts won't represent conditions under which Fed officials would necessarily want to alter monetary policy. They will, however, offer a picture of what combination of outcomes the Fed sees as possible and likely. It's against that benchmark that financial market satisfaction or disappointment will be registered.

Our best guess is that the central tendency for 2004 gross domestic product growth will be put at 3.75% to 4.75% (unchanged from July), for the nation's unemployment rate at 5.25% to 5.75% (lower than the outlook six months ago), and the personal consumption expenditure chain deflator, a widely followed measure of inflation, at 0.75% to 1.25% (also lower). Given these expectations, it's likely that the Fed will opt to keep a steady course on rates. Harris is chief economist for Informa Global Markets

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