29 April 2004, 13:17  Federal Reserve May Drop `Patient' Stance on Rates as Jobs, Inflation Rise

Bond traders have grown impatient with the Federal Reserve's use of the word ``patient.'' On Tuesday, the Fed may finally drop the word from its policy statement, a sign that the first U.S. interest-rate increase since May 2000 is on the way, most of Wall Street's biggest bond-trading firms say. Policy makers will change the language after reports showed gains in job growth and faster inflation, 17 of the 23 primary U.S. government securities dealers said in a Bloomberg News survey.
The central bank has inserted the word in its statement since Jan. 28 to describe how long it can wait to raise its 1 percent key rate from a four-decade low. Three firms said the Fed would maintain the phrasing and three didn't respond to the question. ``I don't think they want an explicit commitment at this point,'' said Stephen Stanley, 35, chief economist at RBS Greenwich Capital Markets in Greenwich, Connecticut. ``They want to be free to go when they need to go.'' The federal funds rate serves as a benchmark for borrowing costs in the U.S. economy, the world's largest. The bank's decisions have implications for consumers and companies by potentially increasing rates on everything from home loans to corporate bonds. In the past few weeks, traders have raised the odds for a rate increase as early as June. Fed Chairman Alan Greenspan's remark last week that deflation, a general decline in consumer prices, is ``no longer an issue'' added to the speculation.
Rising Yields
Yields on two-year Treasury notes, which are more sensitive to changes in monetary policy than longer-dated debt, reached a 20-month high of 2.25 percent this week. The note's yield has averaged about 0.44 percentage point above the Fed's target for the past decade. The average 30-year mortgage rate was 5.94 percent in the week ended April 23, up from 5.38 percent in mid- March, according to housing-finance company Freddie Mac. ``Greenspan's going to want to leave himself some elbow room,'' said Larry Kantor, 51, global head of market strategy at Barclays Capital Inc. ``If he leaves in `patient,' there's less maneuvering room.'' The Federal Open Market Committee said in the statement released after its last meeting on March 16, ``With inflation quite low and resource use slack, the committee believes that it can be patient in removing its policy accommodation.''
`Around the Corner'
That was the same language the Fed used after its Jan. 28 meeting. From August 2003 to January, the policy makers had said they would hold the federal funds rate -- the rate for overnight loans between banks -- low for a ``considerable period,'' a phrase suggesting that an increase was even further off. Mark Lay, chairman of MDL Capital Management in Pittsburgh, with $3.8 billion in fixed-income assets, said he expects the Fed to delete ``patient'' to open the possibility for an August rate increase because inflationary pressure is building. ``Higher interest rates are around the corner,'' said Lay, 40. ``If you tell the market you're going to be patient, that means 2004 is off the table.'' The Labor Department said core consumer prices in March rose 0.4 percent, the most in two years. Should the FOMC change the language when it meets on Tuesday in Washington, it would still leave the Fed at least three months away from a rate increase, most economists said. A separate poll of 74 economists by Bloomberg News found that all expect the central bank to leave its key rate unchanged next week.
No Flukes
Fed policy makers would need another few months of data to show whether March's addition of 308,000 non-farm jobs, the most in four years, and that month's consumer price numbers -- were flukes. ``They're not in any hurry,'' said William Quan, 37, director of research at Mizuho Securities USA Inc. in Hoboken, New Jersey, who projected an August rate boost. ``I don't think June provides enough time.'' Barclays and RBS Greenwich were alone in forecasting a rate increase as early as June. Eight firms forecast an increase in August, including Banc of America Securities and Bear Stearns Cos. In a Bloomberg survey published April 12, only five primary dealers projected a rate boost before September. Primary dealers trade with the Fed's New York branch. Fifteen economists predicted a rate increase this year, up from 12 in the April 12 survey. Futures markets show traders have fully priced in a quarter-percentage point boost by August and see about a 40 percent chance of a June increase.
Not Imminent
September Eurodollar futures yielded 1.74 percent, up about 0.4 percentage point this month. Eurodollar futures settle at the three-month London interbank offered rate, or Libor, which has averaged 0.22 percentage point more than the Fed's target during the past 10 years. The June contract yielded 1.33 percent. James Glassman, 57, chief U.S. economist of J.P. Morgan Chase & Co., said the Fed would replace ``patient'' with new wording to still convey that a rate increase isn't imminent. The Fed may try to underscore the point that the economy needs to add more jobs to replace the 1.8 million lost since January 2001, he said. ``They don't want to give the market the impression it's on the edge of some severe move in monetary policy,'' said Peter Kretzmer, 46, senior economist in New York at Banc of America Securities. The Fed will boost its target rate to 2 percent by year-end, and will start raising borrowing costs in August, Kretzmer said. Greenspan, 78, balanced his statement last week that the fed funds rate ``must rise'' at some point by saying inflation pressures didn't appear to be ``broad-based.''
`Very Gradual'
Fed Governor Ben Bernanke backed up Greenspan. ``That short-term interest rates must eventually normalize is a given,'' Bernanke, 50, said in prepared remarks for the Bond Market Association's annual meeting in New York on April 22. ``The remaining uncertainty about the likely paths of both employment and inflation of necessity implies that the timing of policy changes at this point also remains uncertain.'' ``Tightening will be very gradual,'' said Jeff Speakes, 52, chief economist of Countrywide Financial Corp. in Calabasas, California. Speakes forecast that the Fed will hold off on raising rates until the first quarter of next year, though he said March's labor gains made the prospect of an August increase more likely. Countrywide, BNP Paribas and Nomura Securities International predicted the Fed will keep the mention of ``patient'' in the statement next week. Eight firms predicted no rate increase until 2005, down from 11 making that forecast earlier this month. The government releases April labor data on May 7. The report will probably show the economy added 175,000 jobs this month, according to the median forecast of 19 analysts surveyed by Bloomberg News. ///www.bloomberg.com

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