Updated from 2:48 p.m. ESTThe Federal Reserve left interest rates on hold Tuesday but tweaked its policy statement to reflect the central bank's nagging concerns about the weak labor market. While the statement was almost identical to the one issued in late January, policy officials sounded less bullish on the job market than they had six weeks ago. "Although job losses have slowed, new hiring has lagged," the central bank said. In its last statement, the Fed said hiring remains subdued but "other indicators suggest an improvement in the labor market." The Fed also noted that output is expanding "at a solid pace," not "briskly" as it had said in January. While subtle, the change in language is likely to reinforce the view that interest rates will remain on hold for some time. "I would say the whole statement is very slightly more dovish than the previous statement," said Drew Matus, an economist at Lehman Brothers. The Fed's edict in January led many analysts to believe that policymakers were focusing on other measures of employment besides the monthly nonfarm payrolls. While payrolls have generally been disappointing, the unemployment rate has fallen. Meanwhile, jobless claims have been under 400,000 for many weeks and layoffs as reported by Challenger Gray & Christmas have declined. "This brings people back to reality. The Fed is focused on the payroll survey," Matus said. "While the Manpower survey might be nice and the drop in claims might be nice, what they really want to see is hiring and they're not seeing that." Manpower's latest survey said the job market in the second quarter should be the best in 2 1/2 years. Matus said he isn't expecting a rate hike until the first quarter of 2005. Some economists had expected the Fed to fine-tune its language Tuesday, but they thought any changes would be hawkish. "If Fed officials opt to make changes, they are likely to continue their recent evolution in the direction of sounding progressively less worried about further disinflation and less committed to keeping the funds rate as low as 1%," noted UBS Investment Research economist Maury Harris.
A number of economists had thought the Fed would say that the risks of disinflation -- or falling inflation -- are now equal to the risks of inflation. Instead, the Fed repeated its view that the probability of a fall in inflation is almost equal to that of a rise in inflation. "This is consistent with what we've heard from the Fed between meetings," said Gary Thayer, chief economist at A.G. Edwards. "It shows policy makers are still taking a wait-and-see view on the economy." In January, the Fed dropped its commitment to keep rates on hold for a "considerable period" and instead vowed to remain "patient" in raising rates, something it reiterated on Tuesday. "Increases in core consumer prices are muted and expected to remain low," the Fed said. "With inflation quite low and resource use slack, the committee believes that it can be patient in removing its policy accommodation." As expected, the Fed kept the fed funds rate unchanged at 1%, the lowest level in 46 years. "The committee perceives the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal," policy officials said. "The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation." Stocks initially sold off on the news but ended solidly higher, with the Dow up 82 points. Treasuries rose, with the yield on the 10-year note slipping to 3.69%. While investors cheered the Fed's announcement, concerns about the labor market aren't likely to go away. Pundits note that economic growth is not sustainable without a pickup in hiring. February's nonfarm payroll data showed just 21,000 new jobs were created and most analysts aren't expecting a rate hike until November at the earliest.
"The rule of thumb is when the unemployment rate gets below 5%, the Fed will have to consider moving towards a more neutral stance," said Bob Gay, global strategist for Commerzbank Securities. "Gradualism is the modus operandi of the Fed." Unemployment currently stands at 5.6%.