The Federal Reserve's candor campaign about interest rates seems to have produced decidedly mixed results so far.

In a development the central bank surely did not intend, the stock market, which is sometimes led by bank stocks, has hit a series of record highs in the wake of the Fed's June 30 rate hike.

Why? Nearly everyone thinks it is because the Fed, under its new policy of openness this year, disclosed for the first time immediately after a rate hike that it was not inclined to raise rates again.

Stock market players took that to mean the central bank is finished tightening credit, always a bullish signal for equities. But economists have warned that this may be a mistaken impression.

They note the Fed raised rates five times in 1994 and shifted back to a neutral stance after each move. No one knew this at the time, however, because the central bank's "monetary bias" was then not known until after the next policy meeting.

"Historically, the Fed has usually returned to a neutral bias after tightening monetary policy," Merrill Lynch chief economist Bruce Steinberg told clients this week.

"The fact that the Fed actually told us it was returning to a neutral stance" under its program of greater openness just means the central bank "has not prejudged the situation but will instead focus on upcoming economic data," he said.

"If forthcoming data are sufficiently benign, a second tightening can be avoided," Mr. Steinberg said. He said key labor market and inflation readings will probably be muted enough to preclude further rate hikes. The Fed's next meeting on rates is scheduled for Aug. 24.

Still, investors have been confused by the Fed's new approach and have headed off in different directions. While stock prices have soared on optimism that additional rate hikes are unlikely, bond prices have been far more subdued on skepticism in the fixed-income sector.

In fact, the markets have been more volatile for two months now, because of the Fed's openness. In May the Fed's real-time announcement that it was shifting its policy bias toward raising rates set off a sharp fall in bond prices and bank stock values.

Fed watchers say the central bank's leadership has been dismayed by the unrealistic market reactions to its stepped-up disclosures. Fed Chairman Alan Greenspan said earlier this year that the immediate announcement of shifts in view of policymakers was meant to "avoid misleading markets about the prospects for monetary policy."

Some say the problem is that the Fed has gone only halfway in its move toward openness. When it announced a bias toward higher rates on May 18, then dropped the tightening bias on June 30 after actually raising the federal funds rate by a quarter of a point, to 5%, its customarily spare statements offered only a few sentences of explanation.

"We try to make our announcements very clear, but it's impossible to correct all misperception that may arise," Fed Governor Edward Gramlich said last week.

Some economists say that in hindsight, some uncertainty should have been expected this year after the Fed unveiled its openness policy last winter.

The Fed throughout its history has been a tightly restrained and often secretive body, and its moves toward greater openness are institutionally foreign and hard to get used to-both inside the Fed and among investors.

At the same time, several economists noted, it is important to remember that the Fed's often short, yet complicated, statements represent the consensus of a committee of policymakers. As such, they reflect both differences of opinion and uncertainty about the future.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.