CHICAGO -- One small step in a statement issued by the Federal's Reserve policy-setting panel could lead to a giant leap in the financial markets' perceptions of the central bank's chairman, Ben Bernanke.
The Federal Open Market Committee on Wednesday made waves with a post-meeting statement when it replaced a long-standing reference to the "extent and timing of any additional firming," with a more neutral mention of "future policy adjustments."
The shift suggested that Bernanke was engineering a more flexible approach to policy than many had expected. Some economists had looked for the academia-steeped Bernanke to lead a rules-driven Fed with a penchant for targeting inflation.
Fed watchers said Bernanke — a former Princeton University economics professor — evidently understands the difficult reality of the chairman's job more than some had given him credit for, and after a year on the job accepts that a rigid approach is best left to textbooks.
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Others guess that the FOMC on Wednesday was, at least in part, soothing concerns among some of its members that the central bank's communications had been too explicit about its likely policy direction, potentially forcing an awkward three-point turn if conditions were to change suddenly.
TRANSPARENCY - NOT THE ANSWER?
"When you get to this point in the time of the cycle — when you get to turning points in terms of policy and in the economy — transparency is not necessarily what the Fed desires," said Bill Gross, chief investment officer with the giant bond fund PIMCO. "They want to keep their cards hidden until it is necessary to play them."
Since the FOMC's last meeting in late January, the implosion of the U.S. subprime mortgage sector has threatened both to prolong a housing slump and damage the broader economy.
The Fed's statement shows "it is necessary to emphasize the need for more flexible policy options to respond to unexpected developments," said Thomas Lam, Treasury economist at United Overseas Bank Group in Singapore.
INFLATION ACID TEST
The next test for Bernanke and Co. is whether the Fed would be willing, as it has in the past, to cut rates while inflation is still above the bank's reputed comfort zone — a tough call for a strict inflation targeter.
In recent weeks, markets have increasingly begun leaning more toward that view and were pushed further in that direction by the Fed's statement Wednesday. Futures prices show a 32 percent chance of a rate cut in June, compared with 4 percent after the January FOMC meeting — although among analysts, and possibly at the Fed, opinions vary widely.
"The bottom line from the latest policy statement by the FOMC is that the outlook in its view is more uncertain than before," said Goldman Sachs economists Ed McKelvey and Jan Hatzius.
The Goldman economists, who expect the Fed to lower interest rates by three-quarters of a percentage point this year, said the central bank is now in a position to change course quite rapidly, as it has done at times in the past.
"At its Nov. 15, 2000, meeting, the FOMC said that it was still mainly concerned about 'heightened inflation pressures in the foreseeable future.' Five weeks later, on Dec. 19, economic weakness replaced heightened inflation as the big worry, and on Jan. 3, the committee cut the federal funds rate" by a hefty half-point, they recalled.
Others warned that the Fed would risk hurting its credibility if it soft-pedals the inflation threat at this point.
Among other things, the future inflation rates suggested by prices for U.S. inflation-protected securities, or TIPS, have been creeping higher. TIPS are watched by the Fed as a gauge of inflation expectations.
"The Fed does not, in our opinion, have the latitude to pre-emptively ease monetary policy," said economist Richard Bernstein at Merrill Lynch. "The Fed's concerns on inflation have not abated, and might actually be a bit stronger."
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