War not the only barrier to economic recovery
By Greg McBride • Bankrate.com

The Federal Open Market Committee is scheduled to meet Tuesday March 18. To date, the Fed has been waiting on a resolution to the uncertainty over war as the first domino to fall. In the statement from its Jan. 28-29 meeting, they stated "... geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses." They went on to say "as those risks lift ... (currently low interest rates) will provide support to an improving economic climate over time."

In layman's terms, this equates the uncertainty over Iraq to an elephant standing in the economic road. Until it moves, it is impossible to move forward.

But with the uncertainty dragging on, and the erosion of support for military action to disarm Iraq, each passing day fails to bring us any closer to resolving that issue. Meanwhile, recent economic data has been awful. The employment report released March 7 showed that nonfarm payrolls fell by 308,000 jobs in February, a number that is not explained away by the call-up of military reservists and the weather-related impact of the pummeling storm over Presidents Day weekend. Initial unemployment filings have been north of 400,000 in recent weeks. February retail sales, expected to take a hit due to poor automobile sales, fell by 1 percent even after excluding the impact of the auto sector.

Does this force the Fed's hand? Instead of waiting for the first domino to fall -- the Iraq situation -- will they walk over to the second domino and give it a firm push in the form of a rate cut at the March 18 meeting?

The words "rate cut" are the last two words any investor dependent upon interest income wants to hear, and with good reason. Yields on money markets and certificates of deposit have been in perpetual decline, a decline that accelerated this week and will accelerate even more next week should the Fed trim rates again.

Borrowers servicing a debt load would welcome lower interest rates, as it makes the debt burden lighter and facilitates further borrowing or an accelerated pace of repayment.

While anyone refinancing a mortgage or buying a home is not directly impacted by what the Fed does with short-term rates, as mortgage rates are tied to long-term rates, the prevailing uncertainty has been a boon by pushing mortgage rates to historic lows. As long as the economy remains on unstable turf, these low rates are a tremendous boost by fueling the strength in housing and continuing the refinancing boom. Fed officials don't want to see this trend dissipate until the economy is on firmer ground. Should rates suddenly move higher and threaten the economic rally, expect a barrage of comments from Fed governors aimed at restoring low long-term rates.

But the consensus belief that the economy will suddenly lift and take mortgage rates with it once Iraq is resolved, has plenty of holes in it.

There appears to be a laundry list of things that could work to keep interest rates low, financial markets anemic, consumer confidence dour, and the economy stagnant for weeks or months. After Iraq, North Korea will certainly take center stage. Potential Al-Qaeda reprisals, the possibility of more jobs lost in the airline industry, and the continued reluctance of businesses to hire could all impact economic health. What happens if oil prices don't retreat sharply, as is widely expected, acting as a continued tax on the economy?

For anyone buying a home, servicing a debt load, or dependent upon interest income, the course of events will determine what rates you pay, or what rates you earn.

Greg McBride is a financial analyst for Bankrate.com.

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