Change in tenor

In the wake of the most recent Federal Open Market Committee (FOMC) meeting on March 21, forex traders vigorously sold the U.S. dollar vs. the currencies of countries still perceived to be in rate tightening mode, including the euro, the British pound, and the Australian dollar.

As expected, the Fed left the federal funds rate steady at 5.25 percent — the rate that has prevailed since May 2006. The Fed had been in a tightening mode from June 2004 through May 2006. During that time a string of 17 tightening moves occurred, bolstering the funds rate from 1.00 percent to 5.25 percent.

Although the FOMC left rates alone, analysts zoomed in and highlighted a subtle shift in the policy statement released in the wake of the March meeting. Notably missing from the statement was a reference to potential monetary policy firming, which had been part of the January statement. Analysts said that created “flexibility” for the Fed, opening the door to potential easing.

The Fed statement included the following:

“Recent indicators have been mixed and the adjustment in the housing sector is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters. Recent readings on core inflation have been somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures. In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

However bland the language might be, the changes from previous statements had significant implications.

“Clearly, they changed the risk statement,” says Brian Fabbri, chief economist at BNP Paribas. “It opens the door for a Fed ease, perhaps in the second quarter.”

Economic performance will likely be a key factor in motivating near-term Fed policy shifts. Some economists foresee the potential for the U.S. economy to rebound in the second half, which could soften pressure on the Fed to ease rates.