Never Mind the Bias -- It's the Data That Matter

The Fed may announce a move to a neutral policy bias tomorrow, but that won't mean a thing in October if the economy stays hot.
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To skirt the crime of hubris, potters have pressed their thumbs into a just-thrown bowl. Weavers deliberately missed a stitch. And

Alan Greenspan

and his cronies on the

Federal Open Market Committee

? They went to a neutral policy directive at their June meeting, and assumed that the market knew what that meant.

The policy directive, or bias, was historically used to sanction rate action between FOMC meetings, but as the

Fed

became more open, the meaning of the bias changed. The Fed has become much more open, keen to signal its actions to the market ahead of time. It has, as a result, tended not to move intermeeting in recent years -- last October's emergency cut being an exception -- leaving it open to use the bias announcement as indication of where its tendencies lay. And it was in this spirit (or so it was assumed) that the Fed decided at its December 1998 meeting that it would occasionally announce changes in its bias.

In its May meeting, the FOMC, acting on its new policy, announced that it had gone to a tightening bias. Interestingly, it did not use the word intermeeting when it announced "a directive that is tilted toward the possibility of a firming in the stance of monetary policy." Clearly, what the bias meant

had

changed. Might this not mean, the market reasoned, that if the FOMC moved to a neutral bias at its June meeting, it would be done hiking for now? Never mind that it had, with only a few exceptions, gone to a neutral directive whenever it moved -- and that never kept it from moving at the very next meeting.

And so stocks shot higher when the FOMC wrapped up its meeting June 30, and announced that it had "chosen to adopt a directive that includes no predilection about near-term policy action." Wasn't it obvious? The Fed would not be moving again in August. Hey la, hey la, let's buy.

It was not until three weeks later, when Greenspan delivered his

Humphrey-Hawkins

testimony to the

House Banking Committee

, that the market found out what the bias announcement was really about. At the conclusion of the June meeting, the FOMC

did not believe that its recent modest tightening would put the risks of inflation going forward completely into balance. However, given the many uncertainties surrounding developments on both the supply and demand side of the economy, the FOMC did not want to foster the impression that it was committed in short order to tighten further. Rather, it judged that it would need to evaluate the incoming data for more signs that further imbalances were likely to develop.

It was something of a rude awakening for both the bond and stock markets, both of which had been proceeding as if a hike Aug. 24, though possible, was still unlikely. To some it seems the FOMC might have carried this off a bit better.

Being Clear -- Better Than Not

"Ideally, it's better to say more than less," says Mark Wanshel, financial economist at

J.P. Morgan

. "I think if they had added a second paragraph and said exactly what they meant" it would have been better.

Some even argue that the committee might have simply held off on making any announcement whatsoever. "My issue is not are they neutral or are they biased," says Don Fine, chief market analyst at

Chase Asset Management

. "My issue is announcing the damn thing. The fact that they announced the neutral bias, I think it was a mistake."

Mistake or not, after tomorrow's expected quarter-point hike in the fed funds rate, it is likely the FOMC will again announce its bias, and most Fed watchers suppose that it will be neutral -- and now everybody should know what that means.

"The neutral bias is simply telling market participants they can go ahead and play Fed policy makers," according to John Lonski, senior economist at

Moody's Investors Service

. As with this meeting, the key to further action will be the economic reports. "If those numbers signal a rise in risk, then the Fed will again hike rates at the next meeting Oct. 5," says Lonski.

For Lonski, the disconnect between the markets and the Fed following last meeting's move to a neutral bias was simply part of the "adjustment process" to the new policy on announcing the policy directive. Now Wall Street will know what it means if the FOMC goes neutral tomorrow. It won't run stocks and bonds up too high, thinking that the neutral bias means the Fed's done for the year.

Or let's at least hope the Street doesn't take a neutral bias that way. Because for Greenspan and his colleagues to try to bring such a slow-witted animal to reason -- the mere attempt of it might anger the gods.