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Fed Minutes May Not Show Big Split on Inflation (Update1)
May 24 (Bloomberg) -- The Federal Reserve's Open Market Committee probably wasn't as split on the threat of inflation at its May 3 meeting as bond traders may think, economists said.
Minutes of the meeting, to be released today in Washington, may show that data signaling weakness in the economy had some members fretting about the impact of further interest-rate increases. The dominant view probably reflected that of Fed Governor Donald Kohn, who in an April 22 speech said rates remained below a level that would keep inflation in check. At the meeting, central bankers agreed to raise the benchmark rate a quarter point to 3 percent.
``Markets think the FOMC is divided,'' said Toshiyuki Suzuki, New York-based senior economist at UFJ Bank, Japan's fourth-largest bank. People ``will see something on the hawkish side'' in the minutes, he said.
The yield on the benchmark 10-year Treasury note fell to 4.05 percent today, near the lowest in three months, signaling bond investors see little risk of inflation accelerating. Ten- year securities are among those more sensitive to expectations for inflation, which erodes the value of bonds' fixed payments.
Bill Gross, manager of the world's largest bond fund at Pacific Investment Management Co. in Newport Beach, California, said on May 18 that the 10-year yield may reach a half-century low of 3 percent on expectations inflation will stay contained through 2010. By contrast, most bond strategists predict the yield will rise as economic growth spurs inflation.
The median of 60 forecasts in a Bloomberg survey published May 9 is for the yield to rise to 5 percent by year-end.
`Stick With the Script'
The Fed said in its statement following the meeting that data showed the ``solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices.'' Still, the committee saw the threat of inflation as stronger than the threat of a slowdown: It reiterated a plan to continue to raise rates at a ``measured'' pace as ``pressures on inflation have picked up in recent months.''
``The minutes are expected to stick with the script given in the press release on May 3,'' said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi Ltd. in New York. ``The minutes could throw some cold water on this bond market rally that is partly based on some slow growth stats from the regional purchasing manager surveys'' for manufacturing.
The yield gap, or spread, between two-year Treasury securities and 10-year notes yesterday reached 44 basis points, the narrowest since February 2001. Two-year notes are among the securities most sensitive to changes in the target rate. The narrowing spread suggests bond investors expect the Fed's rate increases will keep inflation contained.
`Rampant' Pessimism
Since June, the yield on the benchmark 10-year Treasury note has fallen about half a percentage point, even as the Fed tripled its overnight lending target and continues to signal more increases are ahead.
Dallas Fed Bank President Richard W. Fisher said in a speech on May 10 that the committee was aware of the ``pessimism rampant in the marketplace about the pace of the economy and rumors about the return of stagflation.''
The FOMC ``did not allow itself to get frazzled,'' Fisher said. ``After looking at the data and considering the tenor of the markets, it was the considered judgment of the committee to stay the course.'' The May meeting was Fisher's first as a voting member of the FOMC.
Three days after the May 3 meeting, the Labor Department reported that employers had added 274,000 jobs to payrolls in April, 100,000 more than expected. The Labor Department also boosted its initial estimate for job growth in March and February by a combined 93,000.
Job Report
Before the employment report ``the financial press was full of articles on the prospects for a soft patch in the economy,'' said William Poole, president of the St. Louis Fed Bank, in a speech on May 11. ``The large increase in employment in April and upward revisions of employment data for February and March dispelled much of the soft-patch talk.''
Kohn said last month that ``the federal funds rate appears still to be below the level that we would expect to be consistent with the maintenance of stable inflation and full employment over the medium run. And if growth is sustained and inflation remains contained, we are likely to raise rates further at a measured pace.''
Since then economic statistics have also shown stronger retail sales and little inflation in April. Retail sales increased 1.4 percent in April, the biggest gain since September, after a rise of 0.4 percent in the prior month, the Commerce Department said on May 12.
Care Needed
At the same time, consumer prices excluding energy and food were unchanged last month, the Labor Department said on May 18. Some economists and Fed officials prefer to strip out costs for food and energy because they are volatile from month to month. It marked the first time since November 2003 that core prices failed to rise. Including energy and food, prices jumped 0.5 percent.
The government's initial first-quarter growth estimate of 3.1 percent at an annual rate is forecast to be revised by the Commerce Department on May 26 to a 3.6 percent pace, according to a Bloomberg survey of 65 economists. The revision would follow a shrinking of the trade gap in March to $55 billion, the narrowest in six months.
The Fed's Poole said policy makers must be careful not to react too strongly to ``high frequency data'' such as monthly jobs and retail sales reports because they are volatile and often revised.
Today's minutes will show a ``reaffirmation that the Fed is trying very hard to look through the short-term fluctuations,'' said Nigel Gault, director of U.S. research at Global Insight, an economic research firm in Lexington, Massachusetts. ``Growth over the year may not be as strong as they thought but the Fed's still pretty optimistic.''