By Evelina M. Tainer, Chief Economist, Econoday
1/5/01

In mid-December Federal Reserve Chairman Alan Greenspan indicated that he might be inclined towards easier monetary policy. The FOMC met a week later, however and no reduction in the federal funds rate target was announced at the time although the Fed changed its bias towards ease. For the most part, market players expected that the Fed would cut the fed funds target at the FOMC meeting at the end of January. Some even suspected that the Fed might act as early as next week - following the employment report. But the Fed managed to surprise financial markets around the world with a 50 basis point reduction in the federal funds rate target two days after the New Year. A few market players indicated that the timing wasn't as much of a surprise as the magnitude of the reduction.

Indeed, the last time that the Fed reduced the funds rate by as much as 50 basis points, the U.S. economy was in recession (1990-91). During the 1990s, the Fed generally moved incrementally, 25 basis points at a time. It is also interesting that the Fed decided to move in-between meetings. In 1994, the Fed began a policy of announcing rate decisions at the end of their FOMC meetings. This would not hamper them during a recession, because the Fed can always act at any time. However, the inter-meeting action does lend a note of distress in the economy.

Many analysts wondered what propelled the Fed to act this past week. Most pointed to the NAPM survey, a sure sign of weakness in manufacturing. We indicated (in our daily update) that the Fed had access to the factory payroll data on Wednesday since it is a regular habit of the Labor Department to give the Federal Reserve Board raw (unadjusted for seasonal variation) factory payrolls and hours data in order that the Fed can get started on compiling industrial production figures. Thus, Greenspan saw the dramatic decline in factory hours worked during the month of December. Combined with the NAPM survey and anecdotal evidence of soggy retail sales figures, Fed officials were inclined to act boldly in advance of their scheduled meeting.