Fed Prognostication Centers on Whether Bias Will Survive

And whether, bias or no bias, monetary policymakers will dare to alarm the markets before the Y2K date change.
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Just when the Street had gotten accustomed to predicting not only whether the Fed would change the fed funds rate, but also whether it would change its so-called bias, the landscape changes.

Regarding tomorrow's

Federal Open Market Committee meeting, the key question is whether the bias will be scrapped entirely.

For the record, virtually no one expects that tomorrow's FOMC meeting will produce any change in the fed funds rate, which has stood at 5.5% since the committee raised it to that level at its last meeting on Nov. 16. (It's simply too close to the Y2K date change to mess with the cost of money, even if the combination of a strong economy and low unemployment rate calls for a higher rate so that inflation doesn't heat up.)

And if the bias survives tomorrow's meeting, most Street economists (20 of 30 primary dealer firms polled by


, with

Goldman Sachs


Merrill Lynch

abstaining) think the FOMC will shift it from neutral to tightening, portending at least one rate hike during the first quarter of next year.

But recent disclosures by the Fed suggest that the bias may not survive tomorrow's meeting. If it doesn't, the focus will be on what, if anything, replaces it, and what the new feature indicates about the future course of monetary policy.

Let's review.

In addition to voting on the fed funds rate at each meeting, the FOMC for years has been voting on a bias, or directive, signifying the likely direction of any change in monetary policy


its next scheduled meeting. A tightening bias signified that any intermeeting rate change was likely to be a hike. An easing bias signified that any intermeeting change would probably be a cut. And a neutral bias signified that an intermeeting change was unlikely.

Before this year, the FOMC didn't immediately reveal its decision on the bias. The decision on the bias would be included in the minutes of the meeting, but the minutes aren't released until a few days after the subsequent meeting, so investors never knew the Fed's current bias. But that wasn't a big deal. The FOMC had long since stopped adjusting monetary policy between meetings on a regular basis.

Then, last December, the committee decided to announce its decision on the bias immediately after its meetings "on an infrequent basis," the

minutes of its Dec. 22, 1998 meeting, released on Feb. 4, reveal. It would announce its bias "immediately after certain FOMC meetings when the stance of monetary policy remained unchanged. Specifically, the Committee would do so on those occasions when it wanted to communicate to the public a major shift in its views about the balance of risks or the likely direction of future policy.

"Such announcements would not be made after every change in the symmetry of the directive," the Dec. 22 minutes continue, "but only when it seemed important for the public to be aware of an important shift in the members' views."

The first exercise of the new disclosure policy came on May 18. The FOMC left the fed funds rate unchanged, but announced in a

statement that it had adopted a tightening bias.

But then, at its subsequent meetings, the committee appeared to toss to the wind all of the guidelines it had drawn in December regarding the circumstances under which it would announce its bias. In short, immediately after every meeting since May, the committee has announced its bias. At three of the four meetings, the fed funds rate was raised. At one, it was left unchanged. Confusion reigned.

And so, at its Aug. 24 meeting,

minutes released Oct. 7 reveal, the committee saw the error of its ways. Fed Chairman

Alan Greenspan convened a subcommittee "to review the wording of its directive, its meaning, and what the Committee announces shortly after its meetings." The meaning of the bias, Greenspan noted, "was subject to differing interpretations," and that was a bad thing. He asked for a report by spring.

At the FOMC's Oct. 5 meeting (

minutes released Nov. 18), the subcommittee was asked "to expedite its report, if possible."

Finally, on Dec. 13, the

Wall Street Journal

reported that the Fed will revise its procedure for communicating with the public as early as this week, and issue a statement explaining the revision either shortly after tomorrow's meeting or early next year. Fed officials are likelier, the


said, "to keep their basic current course, with some modifications, rather than scrapping the experiment or embracing even greater openness. The changes likely will include subtly altering the formula for wording the statements and clarifying the planned frequency of releases."

Hence, the expectation that the 2:15 p.m. EST (approximately) announcement that follows tomorrow's FOMC meeting may include something other than the level of the fed funds rate and the direction of its bias.

But regardless of whether the bias survives as such, most Fed watchers expect some sort of indication from the FOMC that rate hikes are likely next year for the deliciously simple reason that rate hikes


likely next year. That may sound ridiculous, but it's not.

There's no meaningful disagreement on the point that the combination of strong economic growth and low unemployment makes rate hikes likely next year. However, a significant minority of Fed watchers think that the committee will avoid saying so tomorrow because of the possibility that such an announcement would prompt selling in the bond markets -- causing interest rates to spike at a most inopportune time -- right before the Y2K date change, which is creating extraordinary demand for short-term funds.

The disagreement boils down to the opposing views on the likely outcome of the meeting expressed by Henry Willmore, senior economist at

Barclays Capital

, and Mike Moran, chief economist at

Daiwa Securities America


Willmore, predicting that the FOMC will adopt a tightening bias, said in a research note, "Concerns about Y2K-related liquidity problems are unlikely to override the need to provide markets with a sense of where policy is headed."

Moran, guessing that the committee will retain its neutral bias, noted that Fed officials "are displeased with the market volatility that has emerged with the announcement of the bias. With trading likely to be thin in the closing days of the year, the potential for a spike in rates seems high."

"In reality," Moran wrote, "the Fed is leaning toward tighter policy, and in ordinary circumstances, it would adopt a biased directive. But this is not an ordinary situation, and the outcome therefore will differ from the norm."