Human Factor Blamed for Fed Confusion

Human error was probably the culprit behind the mistaken view in financial markets that the Federal Reserve had eased credit recently, economists say.

Sources said people at the Federal Reserve and in the markets were probably responsible for the confusion, which roiled financial markets, produced headaches and anger among economists and dealers, and made for plenty of headline copy during the past week.

“It was costly for the Street, it was costly for our customers, and it was costly for the Fed,” said Steve Slifer of Shearson Lehman Government Securities Inc.

As a result of the confusion, interest rates in the bond market have moved erratically this week.

The Fed last week had signaled that it might be easing credit for the second time in November to stave off a recession, triggering a steep drop in credit market interest rates and raising speculation that big banks would cut their prime rates from the present 10.5%.

But the Fed drained cash from the nation’s banking system Monday for the second straight working day, leading to doubts that the central bank will allow interest rates to move significantly lower.

The confusing signals have spawned a variety of “conspiracy” theories about the central bank, which a Fed spokesman quickly dismissed as “hogwash.”

One theory says the Fed, angered at seeing its recent actions leaked to the news media, “reversed” an apparent easing of credit on Monday to discredit any possible mole.

“You can’t rule it out because of all the other odd things going on,” said Robert Brusca, chief economist at Nikko Securities Co.

The confusion began Nov. 22 when the Fed injected money into the banking system as the closely watched federal funds rate was trading below the Fed’s believed target of 8.5%.

The federal funds rate, the rate that banks charge each other for overnight loans, is closely watched as a barometer of the Fed’s monetary policy.

Rather than announce its actions as they occur, the Fed instead signals its strategy via its open-market operations, which add and drain reserves from the banking system.

Economists believe that Fed officials may well have misjudged beforehand the market’s reaction to the injection of cash on Nov. 22, believing market participants would not view the action as a sign of easing credit.

However, market participants, who had expected looser credit from the Fed because of a slowing economy, quickly jumped the gun.

“The confusion just came about because of miscommunication between the Fed and the Street,” said Slifer.