Fed Uncertainty Over Interest Rates Makes It Long Summer for Investors

By Nell Henderson
Washington Post Staff Writer
Friday, July 21, 2006

Financial markets may be in for a bumpy ride in coming weeks, analysts said yesterday, citing continued uncertainty over whether the Federal Reserve will raise interest rates again at its next policymaking meeting Aug. 8.

Fed policymakers were unsure after their last meeting in late June about what they would do next, according to minutes of the session released yesterday.

The Federal Open Market Committee raised the central bank's benchmark short-term rate to 5.25 percent from 5 percent in June, its 17th consecutive increase in two years. The vote was unanimous, but one member thought that increase "was a close call," according to the minutes, which summarize the discussions without identifying participants by name.

And the group believed additional credit tightening "at future meetings was not foreordained," the minutes said.

Fed Chairman Ben S. Bernanke, wrapping up two days of congressional testimony yesterday, sent no signal about the Fed's next move. Rather, he underscored the uncertainty he and his colleagues face as they struggle to determine the right level of interest rates at a time of both slowing economic growth and rising inflation.

Stocks fell yesterday, as investors shifted their focus to disappointing earnings reports and rising oil prices. The Dow Jones industrial average closed at 10,928.10, down 83.32 points, or 0.76 percent.

Investors, traders and analysts "want interest rate guidance, but they're not going to get it," said Robert DiClemente, chief U.S. economist for Citigroup Global Markets Inc. In his view, the message from Bernanke's testimony and the minutes about the direction of interest rates was, "don't look to us to tell you; we don't have our own consensus."

Analysts said this uncertainty was likely to increase financial-market volatility between now and the August meeting as investors scrutinize every new economic statistic, trying to decide whether it will tilt Fed policymakers toward an 18th consecutive rate increase or encourage them to pause.

Reports are to be released before the August meeting on employment, consumer spending, home sales, factory orders and the economy's pace of growth in the April-to-June quarter. Those figures could confirm or undercut the Fed's forecast of a moderate economic slowdown that lowers inflation over the coming year.

"We're going to get whipped around for the next three weeks," DiClemente said.

Stocks and bonds rallied Wednesday, for example, as many investors interpreted Bernanke's comments on Capitol Hill to mean that a pause in August is possible, and that the Fed may be close to the end of its series of rate increases.

Bernanke declined to comment yesterday, during his testimony to the House Financial Services Committee, when asked if the markets had gotten his message right.

He did say Fed policymakers remained concerned about the recent rise in inflation. They forecast inflation to decline gradually over several years, but that assumes oil prices stop rising and consumers do not start expecting regular price increases, he said.

Bernanke also noted that the Fed's and the markets' "expectations of a leveling out of oil prices have been consistently disappointed in recent years," as the price has shot to more than $70 a barrel now from less than $30 in 2003.

Another factor contributing to market volatility in coming weeks will be the conflicts in the Middle East and other geopolitical tensions, which could drive oil prices higher, said Jason Schenker, an economist at Wachovia Corp. Higher energy prices complicate the Fed's job by boosting the risks of both higher inflation and slower growth.

Fed policymakers said at their June meeting that they had underestimated how high inflation would be this year, the minutes show. They also agreed that inflation might not come down as much or as fast as they now foresee.

Fed "policymakers operate in an environment of uncertainty," Bernanke told Congress. "We have no choice but to regard all our forecasts as provisional and subject to revision as the facts demand."

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