Fed Notes May Hint at End of Rate Hikes

The Federal Reserve on Tuesday cheered stock and bond markets by offering hints that the end of its credit-tightening campaign is in sight.

Or at least, that’s how some investors interpreted portions of the minutes from the central bank’s last meeting. Some analysts, however, said it remained unclear where the ultimate peak in interest rates would be.

The Fed, in the minutes of its Nov. 1 meeting, said policymakers remained concerned about inflation pressures in the economy. But in one sentence that caused an immediate buzz on Wall Street, the minutes noted that “some members cautioned that risks of going too far with the tightening process could also eventually emerge.”

Another passage in the report focused on the language the Fed uses in its post-meeting statements to indicate its assessment of inflation risks and whether interest rates should rise further. Since policymakers began lifting their benchmark short-term rate in June 2004, the meeting statements all have referred to a “measured” pace of ongoing credit tightening.

In the latest minutes, the Fed said that “several aspects of the statement language would have to be changed before long, particularly those related to the characterization of and outlook for policy.”

The report, released after the normal three-week delay, triggered a rally in the bond market that drove down interest rates, or yields, on shorter-term Treasury securities. The news also helped to extend the stock market’s November rally. The Dow Jones industrial average gained 51.15 points, or 0.5%, to an eight-month high of 10,871.43.

Many Fed watchers warned against becoming overly optimistic about an end to rising interest rates, noting that the meeting minutes indicated that the central bank was mostly upbeat about the economy and nervous about inflation risks.

Still, the report gave hope that “there is some light at the end of the tightening tunnel,” said Gary Pollack, head of fixed-income research at Deutsche Bank Private Wealth Management in New York.

Wall Street has widely assumed that the Fed would halt its rate-raising campaign somewhere between 4% and 5% on its key short-term rate. That benchmark, which directly influences other short-term saving and lending rates in the economy, was boosted to 4% at the Nov. 1 meeting, in the 12th consecutive quarter-point increase since June 2004.

Although many investors already figured the Fed was closer to the end of its campaign than the beginning, the meeting minutes offered comfort by reinforcing that notion, analysts said.

“The Fed is trying to develop an exit strategy,” said Anthony Chan, economist at JPMorgan Asset Management in New York.

If the Fed is almost done raising short-term rates, many investors would be expected to begin locking in current bond yields, figuring that rates in general could begin to fall in 2006.

Some investors snapped up two-year Treasury notes Tuesday, driving the yield to 4.31%, down from 4.38% on Monday and a one-month low. Bond yields fall as their prices rise.

The 10-year T-note yield, a benchmark for mortgages, also fell to a one-month low, easing to 4.43%, from 4.46% on Monday. That offered hope of lower mortgage rates, which have been rising for the last 10 weeks.

But some analysts said they wouldn’t bet that bond yields had topped out, assuming that the Fed had at least two rate increases in the pipeline and that the economy continued to show strength.

“Even if they’re done at 4.5% or 4.75%, the two-year T-note yield is going to go higher” in the meantime, Chan said.

The Fed, as usual, offered no specifics in the minutes on how high its key rate might rise.

In the portion of the minutes referring to possible changes in the Fed’s post-meeting statements, the report said that “participants noted that any forward-looking elements of the statement should clearly be conditioned on the outlook for inflation and economic growth.”

Fed officials have long said they expected to stop raising rates when they reached a “neutral” level -- meaning, a level at which their key rate neither stimulated the economy nor slowed it. Even within the Fed, however, there is believed to be disagreement over what constitutes a neutral rate.

Ian Shepherdson of High Frequency Economics in Valhalla, N.Y., said he believed that the economy was strong enough to justify the Fed boosting its rate to 4.75% before stopping.

If he’s right, and if policymakers stay on a course of quarter-point increases at each meeting, they would lift their rate at each of the next three meetings -- Dec. 13, Jan. 31 and March 28.

The Jan. 31 meeting is expected to be the final one at which Alan Greenspan presides as Fed chairman. Ben S. Bernanke, head of the White House Council of Economic Advisors, has been nominated by President Bush to succeed the retiring Greenspan. If confirmed by the Senate, Bernanke would chair the March 28 meeting.

One common assumption on Wall Street is that Bernanke would like to emphasize his inflation-fighting credentials by presiding over at least one rate hike before signaling that the Fed was ready to pause.