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Minding the minutes
How worried is Greenspan about inflation? A look the Fed's May meeting minutes will give some clues.
May 23, 2005: 12:47 PM EDT
By Paul R. La Monica, CNN/Money senior writer
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NEW YORK (CNN/Money) Actions may speak louder than words in most aspects of life, but that's not necessarily true on Wall Street. Just take a look at how investors treat news from the Federal Reserve.

The Fed raised interest rates by a quarter-percentage point earlier this month, the eighth straight increase by policy-makers at the nation's central bank. But investors were far more interested in hearing what the Fed had to say about inflation and the economy. The rate increase itself was viewed as old news.

Now, taking investor's obsession with Fed-speak up a notch, Wall Street's eagerly awaiting the release of the minutes from the Fed's May 3 meeting, which are due out on Tuesday afternoon.

Even though this "news" is actually three weeks old, investors are sure to scrutinize the minutes for clues about the magnitude of future rate hikes and just how many more might be in the offing for the remainder of this year. And depending on what investors see, the release could move the markets.

To that end, investors were thrilled to see in the minutes of the Fed's March 22 meeting that the Fed believed "an accelerated pace of policy tightening did not appear necessary at this time."

Investors interpreted this to mean that the Fed would stick to its "measured" pace of rate increases and not boost the fed funds rate by more than a quarter point at a time. As a result, stocks and bonds rallied sharply after those minutes were released on April 12.

Of course, investors will probably pay the most attention to what the Fed has to say about relatively high price for oil and other commodities and whether those are pressuring businesses to raise their prices for goods and services.

"The market will be focused on anything that gives more context regarding the inflation outlook, how concerned policy-makers are about inflation," said Mark Zandi, chief economist of

The Fed's been moving rates higher at what it's called a "measured" pace to ensure that inflation does not become a problem. To that end, the central bank has boosted the target for the federal funds rate, which helps banks determine their own overnight lending rates, from 1 percent to 3 percent since last June.

Most market observers expect the Fed to raise its fed funds target another quarter point after its next meeting, set for June 29 and June 30.

Measured, or a pause?

But the Fed's also indicated it's not overly worried about inflation, saying in its last five policy statements: "longer-term inflation expectations remain well contained." This phrase is seen as so crucial to the Fed's thinking that the Fed actually issued a corrected statement on May 3 since its initial statement inadvertently left this language out, spooking some on Wall Street. (The Fed puts out full minutes three weeks after its policy meetings).

As such, there is a growing camp of investors who believe the Fed should stop fretting about inflation and should pause soon, rather than keep raising rates. Yields on longer-term bonds, most notably the Treasury's 10-year note have fallen from 4.7 percent last June to about 4.08 percent Monday.

Long-term rates typically fall in times of economic weakness. So the fact that the 10-year yield has dropped while short-term rates are rising suggests many investors are more concerned about a slowdown in the economy than inflation, which tends to be triggered by a stronger economy.

"I don't see inflation as much of a threat. So to get below 4 percent on the 10-year is not a stretch," said Barry James, executive vice president with James Investment Research, an asset management firm based in Alpha, Ohio. "I'm a little afraid that the Fed could be too aggressive with its rate hikes."

Still, wholesale prices rose at a higher than expected clip in April and the April job report showed surprising strength. Many economists say that a healthy job market would keep the Fed on its toes since wage gains are classic precursors to inflation.

So even though the last meeting took place three days before the April payroll numbers were released, David Joy, capital markets strategist with American Express Financial Advisors, said that the market should pay close attention to comments about jobs and hiring.

"The labor market is important to the Fed under any circumstances. Once you get rising wage pressure that's when inflation gets intractable," said Joy.

With that in mind, it would seem unlikely that the Fed would pause anytime soon, regardless of what is revealed in the minutes from the May 3 meeting.

As such, Zandi thinks the Fed will raise rates four more times this year, leaving short-term rates at 4 percent. And he thinks the fed funds rates could go as high as 4.5 percent to 5 percent by next spring if the job market keeps hearing up.

Yet, April's reading of consumer prices, excluding food and energy, showed no increase from March. And as long as there is no indication that corporations are passing on higher costs on to consumers, the threat of inflation appears muted, at best. So that should ease fears of a half-point pike in the near future.

"One thing that's clear is that the Fed is determined to still seem balanced," said David Kelly, economic advisor with Putnam Investments, a money management firm based in Boston. "The minutes will reflect a little more inflation concern and a little more concern about the economy but no deviation from the measured pace."

For more news about the Fed and the economy, click here.

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