The Wall Street Journal  

January 31, 2006 6:47 p.m. EST


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Economists React
To Fed's Rate Increase
January 31, 2006 6:47 p.m.

The Federal Reserve, in its first meeting of 2006 and final meeting with Alan Greenspan sitting at the head of the table, raised interest rates by a quarter percentage point for the 14th time in a row, bringing the federal-funds rate to 4.5%. The central bank dropped the word "measured" from its closely watched policy statement, writing that the committee "judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives." What comes next for interest rates? Economists weigh in:

* * *

The Greenspan legacy came to an end this afternoon with a resounding yawn. We do not believe the omission of the "measured" reference is significant. The minutes from the December meeting revealed that there was considerable discussion regarding this phrase and it was retained at that time simply in order to avoid any confusion regarding the magnitude of future rate hikes. Since rate hikes are no longer guaranteed, there was no need to describe the size of the rate hike.
-- David Greenlaw, Morgan Stanley

My take away is that the FOMC is a bit less dovish at this point than the November and December statements and minutes suggested. I am not sure whether this reflects a recalibration of the communications strategy or a change of heart by policymakers. Perhaps it reflects the removal of Chairman Greenspan, who I suspect was hoping that getting to 4.50% and neutral would be enough to allow him to ride off into the sunset as a hero. In any case, the flow of the data will determine what the Fed does going forward, and we look for strong economic figures and a gradual pickup in core inflation to force several more moves this year.
-- Stephen Stanley, RBS Greenwich Capital

The Fed is no longer signalling an intent to move as it looks towards the March 28th meeting. While the outcome of this meeting is not clear cut, there is however, a bias for rates to move higher.Given the greater uncertainty about the outcome of the March meeting, the committee no longer felt a need to qualify possible further action with the word "measured". The removal of the measured pace phrase, which has been in the statement throughout this tightening cycle, should not be seen as conveying any additional information, beyond the shift from an intent to a bias.
-- Bruce Kasman, J.P. Morgan Chase

Our own view remains that the evidence concerning economic growth should be sufficiently strong in coming months to spur another two quarter-point tightening moves, lifting the Fed funds target to 5.00% in the second quarter of the year. We think that growth will then be moderating sufficiently for the FOMC to cease tightening, even if, as we expect, core inflation drifts up mildly from its current levels.
-- Joshua Shapiro, MFR Inc.

We think strong data will leave Mr. Bernanke with no choice on March 28, but views were split ahead of the meeting. Also, the FOMC repeated the Dec 13 language on "resource utilization", which in plain English means they are scared the low unemployment rate could spark higher inflation.
-- Ian Shepherdson, High Frequency Economics

Greenspan will depart the Federal Reserve having completed (or very nearly so) his final task of restoring a "neutral" monetary policy. Ben Bernanke, confirmed today as his successor, will inherit a policy that will likely require little if any "fine tuning." His first task, however, will be to explain to Congress the actions his predecessor has taken in the waning months of his tenure, Undoubtedly, many will be keenly interested in his take on why the FOMC found this last move to be necessary in the wake of the slowest advance in real GDP in three years.
-- David Resler, Nomura Securities International

The risk suddenly increases that the U.S. may experience a less than graceful soft landing this year. That's because the weakest link in the economy right now is the consumer. Americans have been spending far more than they earned the last five years, borrowing an additional $3.8 trillion during this time and bringing total household debt to a record $10.7 trillion. That may be manageable when borrowing costs were low, but with rates now 3.5 percentage points higher than just a year and a half ago, the burden to service much of that debt becomes more difficult. With household finances already under considerable stress, one has to wonder if another round of rate hikes will lead to a more severe cutback in consumer spending in the months ahead.
-- Bernard Baumohl, The Economic Outlook Group

After 350 basis points of tightening, the Fed acknowledged that monetary policy is a lot less stimulative that it was. However, they did not indicate that they had reached "neutral" nor did they say they would not have to become restrictive. What they did imply was that future Fed actions will become even more data dependent and that further tightening cannot be ruled out. There are a number of significant imbalances that may challenge the new Chairman and his colleagues. We wish both gentlemen well.
-- Steven Wood, Insight Economics

The dollar is rallying across the board because markets saw little change in today's FOMC statement. As we said in our morning note, a statement that conveys little or no change will keep the door open for a March rate hike, hence further enhances the dollar's yield advantage relative to other currencies.
-- Ashraf Laidi, MG Financial Group

This statement leaves the door open for further upward interest rate adjustment by repeating concerns about reduced slack and elevated energy prices as well as by saying that "some further policy firming may be needed." We do not believe, however, that the omission of "measured" suggests that these adjustments will be anything other than quarter-point moves.
-- John Ryding, Conrad DeQuadros, Elena Volovelsky, of Bear Stearns

We really do not believe that Fed policy matters that much except to the degree that they achieve their goals of containing inflation without killing the economy. All the evidence is pointing toward decent levels of economic growth in 2006 and inflation is underneath the 2% upper bound which Bernanke has spoken of targeting. We see nothing in this report that would make us less bullish on equities. Maybe the simple fact that another piece of uncertainty is removed would mean a slight positive for stocks.
-- Ed Keon, Prudential Equity Group

It's time to ask, "what's next?" It's now all about the data. The Fed is essentially at neutral and Mr. Bernanke will have to decide whether to actually start a tightening process. With inflation at the top of the desired level and with the pressures building slowly, the guess is he snugs again.
-- Joel L. Naroff, Naroff Economic Advisors

We would not read much in the elimination of the now famed word "measured." Indeed, the December FOMC minutes were quite clear that it would be a misinterpretation to believe its elimination would be a signal of potentially larger policy adjustment increments in the near future. Back then, the Fed already thought that the number of additional firming steps required would not be large. For now, we still believe that recent changes in financial regulation and tighter supervision for mortgage lending limit the need for a further usage of the overnight rate as a policy tool.
-- Paul-Andre Pinsonnault, National Bank Financial

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