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Fed steady as Y2K looms
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December 21, 1999: 5:35 p.m. ET
Fed holds rates, leaves bias ‘neutral’ as Y2K concerns loom; Nasdaq soars
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NEW YORK (CNNfn) - The Federal Reserve’s policy-making panel left interest rates unchanged Tuesday, and in a surprise, gave no hint about future rate leanings - suggesting the Fed doesn’t want to rock the economic boat as Year 2000 issues lurk.
As widely expected, the Federal Open Market Committee, in its last meeting of 1999, made no change to the 5-1/2 percent federal funds rate, which is the rate that banks charge each other for overnight loans.
But while the economy appears to be hitting on nearly all cylinders, the Fed said its "bias” on rates remains neutral, when most economists expected a shift in the Fed's inclination toward tightening.
Meanwhile, the Fed said it would be on watch for inflation pressures in the new year. Higher rates would help to keep the surging U.S. economy from overheating and inflation under control.
A "smooth transition” the aim
The committee said it wants to ensure a "smooth transition” at the turn of the millennium. Uncertainty looms about the so-called"Y2K bug,” which could cause computers to misread 2000 as 1900 and cause them to possibly shut down altogether.
With the threat of computer nightmares potentially rattling consumers and markets, the Fed has ordered the printing of some extra $50 billion to meet any cash needs, and has made it easier for banks to get short-term loans to meet credit needs.
Stocks rallied on the news, while rate-sensitive bond prices fell, suggesting that investors are still expecting the Fed to hike rates at its next meeting in February.
The benchmark 30-year Treasury bond fell 8/32 in price for a yield of 6.45 percent, to its highest level in two years.
"It looks like a tightening in February is very much in the cards. I think the neutral stance is really just a Y2K issue,” David Sloan, a senior economist with 4Cast, told Reuters. "I think the bond market tone, medium term, is going to remain negative.”
Rising bond rates have in some ways done the Fed’s bidding, by forcing companies to pay more when they borrow. That can put the brakes on economic activity.
An ‘implicit rate cut’
The Nasdaq composite, which hit a new record Monday, exploded up nearly 3.4 percent. Analysts said the Fed’s standing-pat amounted to a rate cut, fomenting a feeding frenzy in high-growth stocks like the Nasdaq’s high-tech issues.
"This is an implicit rate cut,” said Anthony Crescenzi, a bond market specialist with Miller Tabak. "The economy is going to be boosted by the events in the equity market, which will spur growth.”
Crescenzi was citing the so-called "wealth effect” which fosters consumers’ appetites. Investors who make gains in the stock market tend to spend more, and that can prompt the economy to produce more.
The U.S. economic backdrop could hardly be brighter: productivity is surging, inflation is at bay, joblessness is hovering near generational lows, and gross domestic product is growing at a hefty clip of almost 5 percent per year.
The Fed itself referred to a "remarkable rise in productivity growth” in its statement on Tuesday.
Still on watch for inflation
But Glenn Migliozzi, a bond market expert with FleetBoston Financial said climbing oil prices, looming wage pressures and unexpectedly strong economic growth is likely to force the Fed’s hand on rates soon [629K WAV or 629K AIFF].
In its statement, the Fed left little doubt it’s still hawkish about inflation threats, despite its current preoccupation with Y2K-related concerns.
"The committee remains concerned with the possibility that over time, increases in demand will continue to exceed the growth in potential supply, even after taking account of the remarkable rise in productivity growth,” the Fed said. "Such trends could foster inflationary imbalances that would undermine the economy's exemplary performance.”
Many economists expect the Fed to increase rates at its next meeting in February, and possibly several other times as well next year. And the Fed left open that prospect in its statement Tuesday.
"At its next meeting the committee will assess available information on the likely balance of supply and demand, conditions in financial markets, and the possible need for adjustment in the stance of policy to contain inflationary pressures,” it said.
The Fed last raised the fed funds rate by 25 basis points, or one-quarter of a percentage point, at its meeting Nov. 16. It also increased the discount rate -- the rate at which banks borrow from the Fed -- by one-quarter point to 5 percent at that meeting. The Fed has raised rates 3 times since the summer. 
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