By Michael Englund
The Federal Reserve's surprise 50-basis-point cut in the Fed funds target rate on Apr. 18 made clear that the central bank wanted to remain in the easing game. The market focused on the unusual -- and surprising -- timing of the policy change. After all, Fed funds futures, a key trading vehicle for market pros to place bets on the direction of future Fed policy, had increasingly downgraded the likelihood of further Fed moves. And indeed, the market remained notably reluctant to price in substantial further easings beyond the latest policy surprise.
Though there are several alternative explanations for the timing, the most plausible view to S&P is that Fed Chairman Alan Greenspan sees value in maintaining his own easing timetable. He is clearly unwilling to capitulate to market pressure regarding magnitudes or timing of policy changes. Greenspan resisted pressure for more aggressive action at the December and March meetings of the policy-setting Federal Open Market Committee (FOMC), chose to meet expectations at the January FOMC meeting, and opted for surprise easing announcements for both Jan. 3 and Apr. 18.
The chairman values the ability to surprise the markets as a tool in his policy arsenal through these volatile market times, despite contradictory claims by other FOMC members that inter-meeting moves are unlikely.
AN OPEN WINDOW.
Of course, there are other explanations for the timing. It could be that the board has only now come to appreciate the reasons why the financial markets expected a more aggressive policy easing at the March meeting and had expected an inter-meeting adjustment between the FOMC get-togethers in January and March. To wit: Reports had shown the manufacturing sector contracting, inflation seemed under control, and market watchers thought the Fed had a window to move aggressively during those periods.
Alternatively, the Fed may have been comfortable disappointing the markets in January and March because a solid easing trajectory was priced into the markets at those times, so policymakers didn't believe that atypically large moves at those moments were necessary.
In this vein, the Fed may have grown annoyed at the sharp backup in Fed policy expectations over the past week, whereby Fed funds futures started to price in only negligible further easings over the months ahead, and bond yields rose sharply. If the Fed's preferred course is a steady string of easings until the economy recovers, then a midcourse jolt to market expectations at this time may have seemed appropriate.
From a fourth perspective, foreign-exchange traders might have seen a resemblance of the current move to central bank actions in the currency markets, whereby policymakers strike when market movements turn in their favor. The bounce in the U.S. stock market over the past week, and the associated stabilization in the business climate, may have led the Fed to see Wednesday as a good opportunity to seal the market's recovery.
This sort of sensitivity to weekly market fluctuations is the kind of policy fine-tuning that makes most central bankers uncomfortable, but Greenspan may possess enough self-confidence to play this game.
In total, the announced easing had surprisingly little impact on the market's policy expectations going forward, though rates did ratchet down with the announcement. The Fed funds futures market is now discounting only about 10 to 15 basis points of easing in each of the next three months, with the funds rate approaching 4% by midyear.
Interestingly, price movements for the monthly Fed funds contracts suggest that the market is no longer confident that policy changes will occur only on meeting dates. It appears that both the size and timing of future funds rate changes are even more up in the air -- in keeping with Greenspan's policy "game."
Englund is Chief Market Economist for Standard & Poor's