Fed Signals Shift as Traders Anticipate Deeper Rate Reductions

By Craig Torres


Jan. 12 (Bloomberg) -- Federal Reserve officials signaled they've shifted their stance in favor of taking out greater ``insurance'' against the increasing risk of recession.

Fed Governor Frederic Mishkin said yesterday that policy makers must be ready to abandon ``inertia'' and act ``decisively'' in cases of major financial disruptions. Philadelphia Fed Bank President Charles Plosser, whom economists consider to be the toughest on inflation, said he's now most concerned about consumer spending.

The comments, following Chairman Ben S. Bernanke's Jan. 10 speech pledging ``substantive additional action,'' spurred traders to predict a faster and deeper pace of interest-rate cuts. That strategy would be a break from the forecast-driven policy approach to date, Fed watchers said. Mishkin joined Bernanke in stating the strategy is now one of ``insurance.''

``I am delighted the Fed is moving in a very different direction,'' said former Fed governor Lyle Gramley, now a senior adviser at the Stanford Group in Washington. ``Risk-management is what they should be doing.''

Mishkin, 57, a former collaborator with Bernanke on academic research, said in New York that ``waiting too long to ease policy could result in further deterioration of the macroeconomy and might well increase the overall amount of easing that would eventually be needed.''

Disappointing Markets

While the Fed cut the benchmark rate by a half-point, more than anticipated in September, officials have since disappointed some investors by refusing to commit to a series of reductions. When lowering borrowing costs in October and December by a quarter-point each, policy makers refrained from saying that growth was a bigger concern than inflation.

By the time they met Dec. 11, officials acknowledged that the Fed's stance ``appeared to be somewhat restrictive,'' minutes of the session showed last week.

``They underestimated the magnitude of the credit shock,'' said Brian Sack, senior economist at Macroeconomic Advisers LLC in Washington. ``The markets got it a lot faster than the Fed and now they are catching up.''

Plosser, 59, said he's ``certainly'' open to more rate cuts, in an interview with PBS's Nightly Business Report yesterday. By contrast, when he spoke Nov. 27, he warned that the Fed's rate cut the previous month posed a risk to inflation expectations.

``The most thing we are concerned about right now is consumer spending,'' Plosser said.

Boston Fed President Eric Rosengren, 50, said yesterday in South Burlington, Vermont, that declining house prices are ``likely to damp consumer and business confidence in spending.''

`Gasoline on the Fire'

``Rosengren, Plosser and especially Mishkin arguably poured more gasoline on the fire'' after Bernanke's remarks, Ian Morris, chief economist at HSBC Securities USA Inc., said in a note to clients. ``The market is betting that the Fed may cut in an inter-meeting move,'' wrote Morris, who Jan. 10 doubled his rate-cut call for this month to a half-point.

Traders anticipate at least a half-point reduction in the target rate for overnight loans between banks this month, according to contracts quoted on the Chicago Board of Trade.

Odds of 0.75 percentage point of reductions this month jumped to 34 percent, from zero on Jan. 10, futures show. That suggests some investors see the chance of a move before the Federal Open Market Committee meets Jan. 29-30, with an additional cut when it gathers.

Bernanke's Opportunity

Bernanke, 54, will have another opportunity to send signals on rates Jan. 17, when he testifies on the economic outlook before the House Budget Committee.

This week's shift may have been driven by the Labor Department's Jan. 4 report showing the jobless rate jumped to 5 percent in December, economists said. The figures also showed the first decline in private-sector employment since 2003.

``We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks,'' the Fed chief said to the Women in Housing and Finance and Exchequer Club in Washington. ``The committee must remain exceptionally alert and flexible.''