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Wall Street overreacted
to Fed language change
NEW YORK >> To the untrained eye, it looked like good news: The Federal Reserve offered an upbeat assessment of the job market and left a key short-term interest rate at a historic low, saying it could afford to "be patient" with its policy.
But Wall Streeters were rattled by what the Fed didn't say -- that it would leave rates low "for a considerable period," a line from previous statements that many interpreted as meaning a year or more. The idea that rates could rise as early as this spring or summer sent stock prices lower and bond yields higher, to the dismay of anyone shopping for a mortgage.
The obsession with a few words confirms that interest rates are a serious issue for the markets. The expected rise in the federal funds rate, now at a 45-year low of 1 percent, will dent corporate bottom lines by raising the cost of their debt, and decrease the underlying value of their stocks.
Concern about when the increase will come and how large it will be is likely to unnerve the markets further as investors try to anticipate the Fed's next move. But many economists say it's not that big a deal.
"I think people should make much less of this than what they've done," said Sherry Cooper, chief economist at BMO Nesbitt Burns, who worked for the Fed from 1977 to 1982. "The difference to them between 'considerable period' and being 'patient' is not statistically significant. Patience is patience. No one can say how long it takes."
What it does mean, Cooper and other economists said, is that Fed chairman Alan Greenspan and other members of the central bank's Open Market Committee will be closely watching economic data, especially on inflation and the labor market. A lower-than-expected gross domestic product reading for the fourth quarter, released yesterday, made some think it would be quite a while before a change is made.
Cooper thinks rates will edge higher in August. Most economists doubt the Fed will take action too close to the presidential election in November. Some, including Mitch Zacks, director of research at Zacks Investment Research, think economic conditions won't justify a rate hike until 2005.
"Just because they say it's possible they'll raise rates doesn't mean they're going to," Zacks said. "(Greenspan) wants to keep his hands free, in case he does see inflation. He wants the freedom to pull the trigger."
No matter when rates rise, they're likely to remain at historically low levels. Even if the federal funds rate was doubled to 2 percent, it would still be at a 30-year low.
Minutes from the Fed's December meeting, released Thursday, indicated Greenspan and his colleagues were growing concerned about the way investors were interpreting their statements on rates. A number of FOMC members wanted to drop the "considerable period" reference, or at least associate it more clearly with economic conditions rather than just the passage of time.
No matter how much Greenspan and his team want to put investors on notice that change is coming, chances are good many will still be caught off guard, said Sam Stovall, chief investment strategist at Standard & Poor's Corp. In the past when rates have gone up after a long period of lows, investors "rarely saw it coming," he said. Share prices for companies in the S&P 500 declined an average of 3.7 percent in the six months following initial rate increases.
Lesser declines were seen in so-called "defensive" industries, where demand tends to remain static regardless of economic conditions: alcoholic beverages, household products, communications equipment and hospital management. More economically sensitive industries -- gold and precious metals, homebuilding, household furnishings and appliances, savings and loans and trucks and parts -- saw deeper losses.
"It seems like by changing the language, in a sense, the Fed is saying 'look out below,"' Stovall said.
So does that mean small investors should run for the doors? Not necessarily, Stovall and other analysts said. The outlook for equities remains strong. For investors with a disciplined approach, a short period of declines could be a buying opportunity.
"I think everyone recognized that the Fed would have to raise rates at some point," said Harvey Hirschhorn, head of active asset allocation and strategy for Columbia Management Group. "When all is said and done for this year, it's not going to be that major of an event."
For the week, the Dow Jones industrial average was down 80.22, or 0.8 percent, at 10,488.07.
The Nasdaq composite index declined 57.72, or 2.7 percent, to 2,066.15. The S&P 500 lost 10.42, or 0.9 percent, to 1,131.13.
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