-Caveat Lector-
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--- Begin Message --- -Caveat Lector- Fed abandons balance, market scents division
By Wayne Cole
NEW YORK, March 18 (Reuters) - The world's most powerful central bank on Tuesday admitted it could not predict where the U.S. economy was heading in the short term.
The Federal Reserve confounded analysts by abandoning the procedure of the past three years and dropping its assessment of "risks" to the economy, conceding that geopolitical uncertainty was so great that it could not usefully characterize the balance of risks.
The tortuous wording of its post-meeting statement left markets confused, but spoke volumes to economists.
"It suggests there's much disagreement within the Fed on how much of the economy's troubles are geopolitical and how much fundamental," said David Resler, chief economist at Nomura Securities International. "They couldn't agree, so they dropped the assessment altogether."
The break with tradition might even mark the end of the this particular formula of communication by the Federal Reserve Open Market Committee (FOMC) which sets U.S. monetary policy.
"This was not a helpful move for markets that crave clarity," argued Resler. "It's time they got rid of this assessment altogether and adopt something new."
Others agreed.
"The Fed has muddied already murky waters with this and it's about time they tried something else," said James Glassman, senior economist at J.P. Morgan.
Indeed, the whole statement that followed the Fed's policy meeting was replete with caveats and contradictions. The central bank said it was disappointed with recent data but still confident that as geopolitical uncertanty lifts the economy would recover.
At the same time the outlook was too uncertain to assess the "risks" to the economy, and the Fed instead pledged heightened "surveillance" on the economy.
"It's all very peculiar," said a perplexed Glassman. "They seem to be signaling they are ready to cut rates but they'd prefer to watch and wait. For me, the data recently has been so bad I don't know what else is necessary for them to cut."
COMMUNICATION BREAK-DOWN
This is not the first time the Fed and markets have not seen eye to eye on their assessment of economic risks.
It announced the particular verbal formula of assessing "risks" in January 2000 in part because the former policy of expressing a "bias" toward higher or lower interest rates had led to confusion among the public and markets about what the Fed intended.
This, the Fed said, led to exaggerated responses to bias changes, particularly toward tightening monetary policy or raising interest rates.
But if the Fed's new wording was aimed at lessening speculation about future policy moves, it apparently failed.
In November, the central bank puzzled many by cutting interest rates an aggressive half a percentage point while at the same time changing its assessment away from economic weakness to one balanced between slow growth and higher inflation.
The minutes of that meeting show many members argued that retaining the weakness bias would raise the odds of an overreaction in financial markets.
Investors, the Fed feared, might misread the decision as a sign that FOMC members were more concerned about the economy than they really were, and thus put greater odds on another easing than was warranted.
The implication is that markets can't be trusted to correctly interpret the Fed's cryptic comments and that mistrust seems to have led to contortions in logic which undermine the whole point of the policy guidance.
In particular, some argued that it strained credibility to argue, as the Fed did last November, that the risks to the economy were balanced between weak growth and rising inflation.
"There's a presumption by the Fed that markets are permanently stupid," said Ram Bhagavatula, chief economist at Royal Bank of Scotland Financial Markets.
"It leads them to muck up their communications with this official, traditional terminology, and it leaves us analysts all at sea. Why does policy have to be so mysterious? Can't they just tell us what they're thinking?" he lamented.
Copyright 2003, Reuters News Service
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