Fed Laid Groundwork in December for Jan. 3 Surprise Cut, Minutes Show

Many Fed watchers assumed the Federal Open Market Committee's Jan. 3 decision to cut rates between meetings was hasty, driven by near panic. But it now seems clear that that wasn't so.

Minutes released Thursday indicate that at its Dec. 19 meeting, the FOMC left open the possibility of cutting rates before the next scheduled meeting if the economy showed further deterioration. In fact, it is apparent that voting members who would have preferred to cut rates at the December meeting were assuaged by the FOMC's intention "to act promptly in coming weeks, including the possibility of an easing move early in the intermeeting period, should confirming information on weakening trends in the economy emerge." And minutes of the FOMC's Jan. 3 conference call lend an air of ordinariness to what had been termed by some an "emergency meeting."

"There was no reluctance about moving intermeeting, no apprehension," notes J.P. Morgan economist Marc Wanshel. "It seems it was expected that they might do it."

Feeling the Chill

The minutes also make clear that the FOMC was aware at the December meeting that the economy could be slowing rapidly, but committee members felt they lacked the hard data to quantify whether that was actually what was happening. At that point, the FOMC felt that the evidence of a pronounced slowing in the economy "was very recent and to an important extent anecdotal." Because there were several occasions in recent years in which the economy appeared to be on the verge of a slowdown, only to quickly resume rapid growth, the committee decided to wait a bit -- and then move promptly when further evidence of weakening came along.

Such evidence came. By Jan. 3 "there was mounting evidence of deterioration," says Banc of America Securities chief economist Mickey Levy. "They knew from the Christmas season that chain-store sales were weak. Automobile manufacturers announced absolutely horrendous December sales. Also, a lot of businesses that had hoped for a soft decline had changed their expectations and saw the need to slash expenses."

Because of these factors, "the expansion was clearly weakening and by more than had been anticipated," according to the minutes of the Jan. 3 conference call. "In the circumstances, prompt and forceful policy action sooner and larger than expected by financial markets seemed called for." Since the financial markets were already pricing a high probability of a quarter-point cut before the next meeting, the Fed had to go with half a point. The vote was unanimous.

Monitoring

Though the fed funds futures are pricing in a slight chance of another intermeeting move in the weeks ahead, there's a general sense that it won't happen. In the statement it released following its December meeting, the FOMC said it would "continue to monitor closely the evolving economic situation." That language was not included in yesterday's statement.

"It's possible we get another intermeeting move," says Credit Suisse First Boston economist Mike Cloherty, "but you need either incredibly soft data or a lot of stress in the financial markets."

But in considering what's next, one must note the FOMC's apparent unconcern over the ramifications of an intermeeting move. The minutes don't suggest that anyone so much as considered what kind of message such a cut could send to financial markets. So one mustn't overlook the possibility that the Fed could strike again.