What's the Word from the Fed?

It's not likely to raise rates this week, so read carefully what it has to say after what's likely to be a spirited debate at its meeting

By Rich Miller

Actions speak louder than words, or so the old saw goes. But when it comes to the May 4 meeting of the Federal Reserve's policymaking committee, words will be the things to watch. With the Fed universally expected to hold interest rates steady, the key for investors will be what Chairman Alan Greenspan and his colleagues have to say after the meeting about the economy and the future stance of monetary policy.

So what's likely to come out of the widely anticipated gathering? Expect a rhetorical tightening of the Fed's stance that lays the groundwork for a possible rate hike sometime during the summer. The Federal Open Market Committee, the Fed's policymaking arm, will acknowledge that deflation is no longer a danger, take note of recent signs of job-market improvement, and probably drop its previous pledge to be patient when it comes to raising rates.

INFLATION PROBLEM?

  That may not seem too surprising. However, the discussion during the meeting promises to be lively. In the statement the FOMC issued after its last meeting on Mar. 16, the central bank said ebbing inflation was a greater risk to the economy than rising prices. With a host of companies from steel producers to soapmakers announcing price increases since then, that's clearly no longer the case.

Some monetary mandarins, including St. Louis Fed President William Poole, are likely to argue that rising inflation is now the bigger danger. But Greenspan doesn't appear ready to go that far, and his words carry the most weight. With productivity still strong and ample capacity in the economy, the Fed chief thinks inflation will stay low. The bottom line: The FOMC is likely to tell the world that the risks of falling and rising inflation are equal, although it could add that it remains vigilant about keeping price rises in check.

Greenspan is likely to counsel caution when it comes to altering the committee's assessment of labor-market conditions. Sure, the Fed will want to acknowledge that the jobs picture has improved, especially after the 308,000 increase in nonfarm payrolls in March. But with the Labor Dept. due to release the April jobs numbers on Friday, May 7, the FOMC will want to avoid sounding too optimistic lest the figures don't bear that out.

ON ITS WAY OUT.

  The most intense discussion will likely center on what it should do with its promise of "patience" on the rate front. Some, perhaps including Fed Governor Ben S. Bernanke, will probably argue that the pledge should be retained because it provides markets with a useful signpost for the central bank's future actions. By dropping it, the Fed risks giving markets the impression that a rate hike is at hand, those policymakers are likely to argue.

But Greenspan's failure to repeat the promise when he testified to Congress on Apr. 21 was a sign that the phrase is probably on its way out. Keeping the pledge alive could tie the Fed's hands, which Greenspan is loath to do at a time when the economy finally looks to be on a path of sustainable recovery.

Regardless of how spirited the FOMC's discussion may be behind closed doors, collegiality is the byword when Greenspan & Co. meet to discuss monetary policy. Everyone gets a say and is listened to respectfully. But in the end, Greenspan's words carry the day -- and they'll shape the statement the committee issues. And for this meeting, at least, that statement will be where the action is.

Miller covers the Federal Reserve for BusinessWeek in Washington, D.C.

Edited by Beth Belton

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