Fed, Concerned by Y2K, Leaves Rates on Hold
The Federal Reserve left interest rates unchanged Tuesday, explaining that while it harbors concerns about inflation, its top worry for the short term is getting through the millennial rollover without any economic shocks.
The Fed’s Open Market Committee also said it was staying officially neutral on whether it was leaning toward an interest rate increase or decrease.
Though the committee, in a prepared statement, emphasized potential “inflationary imbalances,” its members evidently decided that their most urgent task for now was to calm public jitters about Y2K computer glitches and the possibility that they could trigger bank runs.
“The focus . . . must be ensuring a smooth transition into the year 2000,” the committee stated.
The decision, while widely anticipated, still delighted Wall Street. The Dow Jones industrial average ended the day up 56.27 points at 11,200.54 after being down as much as 46 points before the Fed’s announcement. Nasdaq gained 127.28 points, its biggest daily gain ever, to 3,911.15.
Prices of long-term bonds dipped, however, with the yield on the 30-year Treasury bond rising to 6.46% from its Monday close of 6.44%.
Although investors seemed to bet that plentiful credit would propel stock prices upward for at least the six weeks until the Fed’s next meeting in February, economic analysts noted that the Fed has been signaling heightened concerns about inflation lately.
“It’s implicit in their statement that they may very well have tightened if it hadn’t been for the Y2K thing,” said Robert V. DiClemente, managing director at Salomon Smith Barney/Citibank.
In recent weeks, various Fed officials have been making tough pronouncements about the possibility that America’s fast economic growth and tight labor markets are finally triggering long-awaited inflation. Boston Federal Reserve Bank President Cathy Minehan, for instance, warned earlier this month that “there is a case to be made that the economy has been growing beyond what is sustainable.”
Such statements, and the evident failure of the three interest-rate increases in 1999 to significantly dampen growth, have many private economists thinking that despite Tuesday’s reiterated “neutral bias,” the Fed will raise interest rates as early as February.
“There is a very narrow window of opportunity,” said Sung Won Sohn, chief economist at Wells Fargo & Co. As he sees it, the Fed will want to get any interest-rate increases over with before next year’s presidential campaign is in full swing.
But first, the Y2K rollover. While experts say there is little reason to expect massive computer failures in the U.S. financial system, Tuesday’s action shows that the Fed is still concerned about erratic human behavior.
“In the United States, it’s more of a psychological problem than a computer problem,” Sohn said.
He said, for example, that a coincidental power outage on New Year’s Eve could prompt people to assume the worst, rush out to the store for emergency supplies and stop to withdraw cash on the way.
To keep such overreactions from escalating into full-blown bank panics, the Fed has been pouring extra cash into all the regional Federal Reserve banks and setting up a special lending window for banks that suddenly need money. All told, it has added an estimated $50 billion--nearly $200 for every man, woman and child in America--to the financial system in recent weeks.
“They’ve done massive volumes of pumping reserves in,” DiClemente said. “I would count on them to try to even things up in February,” with a possible interest-rate hike to get the excess liquidity back out of the system before it fuels inflation.
Economists aren’t certain what economic impact an extra $50 billion for six weeks will have.
David W. Berson, an economist at the Fannie Mae mortgage lending agency, said it depends on how many people ultimately decide to take a little extra money out of the bank, just in case, for the millennial rollover.
“Maybe it’s just an extra 20 bucks in case the ATMs are down for a day,” he said. But those 20 bucks could add up to a fortune if everybody had the same idea.
“What people have not considered is the excess inventory of money,” Berson said. “Maybe you’ll put some of it back, but some of it’s going to get spent. So there is an additional inflation risk with all this.”
