FOMC Unlikely To Say Much About Market Tumult

Singed by market turmoil, many investors may want the Federal Reserve to offer some comforting words for their pain at next week's policy meeting, but economists call such hopes unrealistic.

Analysts reckon central bankers are unlikely to acknowledge in any significant fashion the unsettled and tense markets at the end of Tuesday's Federal Open Market Committee meeting. They believe the Fed has few upsides in commenting on the broad-based difficulties faced in stock and credit markets. And the downsides are such that central bankers will likely just keep their counsel on economic matters to themselves. "I don't think they want to address this directly," said Michael Feroli, economist with JPMorgan. "They don't want to sound like they are coming to the rescue of financial markets," he said. "I think these guys will do the right thing and not capitulate every time the market has some tremors," he said. To be sure, unlike some of the other flare-ups endured by markets over recent months, the troubles faced now by investors across a broad array of asset classes are being viewed as a potential threat to growth. But economists say it's too early in the process to know how things will shake out, and that means it's too soon for the Fed to face matters head on. Economists see a narrow window the Fed could use to address falling stock markets, rising bond prices, and borrowers' increased difficulties in finding financing. Central bank watchers speculate policy makers could flag tightening credit conditions as threat to their growth outlook. But even if the Fed takes that step, few expect policy makers to go any further, given that thus far financial markets have not suffered the sort of systemic breakdown history shows would draw the Fed in. At the same time, the economic outlook that drives monetary policy remains one where growth is expected to continue. Moreover, Fed officials have shown little pullback in their concerns about inflation, making it harder for them to open the door to a rate cut via statements of concern about falling asset prices. For Avery Shenfeld, economist with CIBC World Markets, a mention of credit's influence on the economy "gives them the opportunity" to change their monetary policy outlook if they deem it necessary, without committing rate policy to any specific course. But going any further is dangerous. A policy statement acknowledging recent markets events has the possibility of reinforcing investors' fears, rather than lowering them. By noting the troubles, the Fed clearly puts the matter front and center, which could make some investors even more apprehensive than they already are. The Fed has only a few words in its typically terse policy statement, and what officials choose to highlight can mightily influence how the market views itself. Already, some believe this fear is why the Fed has been so reluctant to take on the subprime mortgage troubles in greater detail in its policy statements. Instead, the Fed has danced around the issue via shifting assessments of the housing sector, giving the matter a fuller airing only in the meeting minutes of FOMC gatherings and in the comments of officials. Moreover, the Fed doesn't want to be seen as bailing out investors' bad decisions. "We know they want to get away from the Greenspan put idea" and next Tuesday offers a prime opportunity to do this, JPMorgan's Feroli said. He was referring to the market's belief that under the former chairman, the Fed would act to put a bottom underneath falling stock prices.

Tackling Troubles To be sure, the Fed doesn't always shy away from commenting on market turmoil. But when it's highlighted in an FOMC statement, it's a really big deal. In 1998, when central bankers cut rates in response to the ongoing aftermath of hedge fund Long Term Capital Management's collapse and global market turbulence, the FOMC tied financial troubles to the broader economy. It said then "growing caution by lenders and unsettled conditions in financial markets more generally are likely to be restraining aggregate demand in the future." The Fed also cut rates immediately in the wake of the Sept. 11 2001 terrorist attacks. Again, its baseline justifications were economic, but policy makers, reflective of the profound troubles then suffered by markets, promised to provide whatever liquidity was needed, and recognized market functioning was impaired. By the time of the Oct. 2 2001 gathering, which also brought another easing, the FOMC went back to a wholly economic rational for action, and offered no acknowledgement of market conditions. So far, Fed officials have not had many opportunities to comment on the events that began last Thursday, so it's hard to know what their level of concern is. If their response to the subprime mortgage trouble that is at the root of markets' woes is a guide, then officials may not yet be all that worried. Indeed, Fed officials have broadly argued that subprime problems are thus far contained. Fed Governor Randall Krozner said in reconfirmation hearings Thursday the economic outlook remains "unchanged" even as policy makers continue to watch market developments. Earlier in the week, St. Louis Fed President William Poole took matters on more directly. But he didn't offer much, saying "the Fed doesn't know, and market participants do not know either, the full implications of last week's stock market declines and increases" in risk premiums. Poole added, "market reactions last week may be overdone, or perhaps not."