Fed's Timing On Rate Cuts Puzzles Traders

The Federal Reserve's Nov. 6 easing was expected - and then again, it wasn't.

After predicting a discount rate cut for about a week, many bond market experts were surprised that the Fed reduced the rate midway through a three-day auction of $38 billion in Treasury securities.

Easing the discount rate and the fed funds rate target in the middle of a Treasury auction can upset dealers' bidding arrangements, which usually roils the government bond market.

"There is a certain body English to operating in the market that the current Fed leadership doesn't possess," said one Fed watcher.

The precise impact on interest rates is impossible to measure, but poor timing might interfere with the Fed's objectives, according to some experts.

"In terms of getting the market to go where [Fed officials] want it to go, it has definitely hurt them," said Neil Soss, chief economist at First Boston Corp. "It has hurt the Fed's ability to induce long-term rates lower."

Effect on Long-Term Rates

Some prominent economists are even saying that the unusual timing of this move and others leaves bond market participants uncertain about the Fed's policy objectives. As a result, they are unwilling to pay more for long-term bonds. That leaves long-term interest rates relatively high and makes it harder for the economy to start expanding again.

A mid-auction easing hurts government bond dealers, who often sell Treasury securities short on the morning of an auction. They sell securities they don't own in the hope that new supply will push prices down, enabling them to buy the securities at the lower price and pocket the difference.

But Treasury prices usually rise when the Fed cuts interest rates, forcing short sellers to pay more to obtain the bonds they had sold earlier. Although the Fed obviously does not have to guarantee that dealers make money, it is in the Fed's interest to maintain an orderly market that attracts investors.

Reacting to Poor Auction?

One explanation for the latest action may have been the Fed's response to a dismal auction on the first day of the three-day series, according to some observers.

Other observers attributed the timing to political pressure from the Bush administration. The Fed acted just hours after former Attorney General Richard Thornburgh lost his bid for a U.S. Senate seat in Pennsylvania. The closely watched race pitted Mr. Thornburgh, a Bush insider, against a newcomer, Harris Wofford, who campaigned on a populist platform of giving middle-class taxpayers a break from the recession.

The Nov. 6 easing followed a similar move Oct. 30 that did not trigger as much head-scratching about its timing. But because of the method used by the Fed in October, market participants were initially unsure there had been an easing.

In that earlier move, the Fed passively allowed the fed funds rate to fall instead of following its usual practice of actively nudging the rate down - leaving analysts baffled for a time.

Decisiveness Wanted

"When you are really intent on easing, I don't know why you would hide your light under a bushel," said one miffed economist.

Fed officials defended the timing of these recent steps and dismissed traders' complaints.

Traders who were surprised "should have their heads examined," said a Fed spokesman. He cited an October speech by Fed Chairman Alan Greenspan that addressed the sluggish economy and insisted that letting the fed funds rate decline Oct. 30 was consistent with Mr. Greenspan's remarks.

"If [market participants] were not expecting a move that Wednesday [Nov. 6], those people shouldn't be in the market," the spokesman said.

Some experts do give the Fed high marks for the handling of its rate cuts. David Jones, chief economist at Aubrey G. Lanston & Co., said an easing Sept. 13 was well executed.

But even Mr. Jones was less enthusiastic about the actions in early November. He said Mr. Greenspan is not terribly concerned about preparing the market for policy changes and that shows up in instances like the mid-auction easing.

"One of the weaknesses of the Greenspan Fed is that, sometimes, it doesn't prepare the market or the economic decision makers adequately for what it's going to do," Mr. Jones said.

PHOTO : An Odd Time for Easing

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