Sunny Fed leaves no doubt about another
rate increase
By Greg
McBride, CFA • Bankrate.com
Another Fed meeting looms with another quarter-point
interest rate hike virtually assured. It may seem strange that the
Fed continues to raise interest rates on the heels of a summer-long
economic soft patch. However, the course has been set for recent Fed
interest rate moves, and as far as the Sept. 21 meeting is concerned,
the Fed has left little room for deviation from the current course.
Communication is a high priority at the Fed as they
don't want to surprise financial markets when it comes to raising
interest rates. So it is no accident that Greenspan sent a strong
signal about the upcoming Fed meeting in testimony before the House
Budget Committee on Sept. 8.
Greenspan was again optimistic on the economy, stating
that the "expansion has regained some traction" and that
"inflation and inflation expectations have eased in recent
months." At that point, the intent to raise rates another quarter-point
on Sept. 21 became clear.
Greenspan has expressed confidence in the strength
of the economy before, during his July Humphrey Hawkins Congressional
testimony and, along with other Fed governors, in prior Fed statements.
While saying in each post-meeting statement since May 2003 that
the upside and downside risks to economic growth and low inflation
are roughly equal, Greenspan and Fed governors lately give little
hint of any pessimism. Instead, the recent stance has been that
any economic soft patch is temporary and largely attributable to
sharp increases in energy prices.
Has this view been proven correct? It is too early
to say, but there are other considerations.
With another quarter-point move, the Fed will have
erased the post-2001 "insurance" interest rate cuts enacted
in Nov. 2002 and June 2003. These were instituted when the economy
continued to flounder following 11 interest rate cuts in 2001. With
the economy expanding in 2004 -- the uneven pace notwithstanding
-- the insurance of a Fed funds rate at 46-year lows was no longer
needed.
Keeping inflation from accelerating added some urgency
to the Fed's cause in raising rates this year, even if it meant
doing so amid an uneven economic expansion. By intently raising
interest rates in August and again in September despite dubious
economic evidence, this is the Fed's way of staying ahead of inflation
and answering the critics who just months ago claimed the Fed was
behind the inflation curve.
The Fed still has a good bit of work to do to return
the federal funds rate to the neutral level -- the point that neither
stimulates nor restrains the economy -- that is commonly believed
to be in the 3.5-percent to 4-percent neighborhood. By increasing
the fed funds rate to 1.75 percent on Sept. 21, the Fed now has
a little latitude to hold off on further increases, at least until
such a move is justified by a stronger economic environment.
Whether the Fed continues to increase rates at each
future meeting is less certain. Unless the cycle of economic data
seen between now and upcoming meetings on Nov. 10 and Dec. 14 indicates
a robust recovery, the Fed is expected to refrain from raising rates
at one of those meetings. Market expectations currently call for
the Fed to hold off at the November meeting before bumping rates
another quarter-point higher in December.
The Fed's effort to raise short-term interest rates
enough to quell immediate inflation concerns is paying dividends.
The Sept. 16 release of the Consumer Price Index showed that inflation
is still tame, as both the headline CPI and core CPI came in below
consensus forecasts. Over the past 12 months, the CPI is up 2.7
percent, down from a pace of 3.2 percent in June.
Keeping inflation from accelerating has an additional,
important benefit. With inflation low and moderating, this helps
to keep long-term interest rates low and further sustain another
important crutch to the economy -- the housing market. As proof,
the average 30-year fixed-rate mortgage from Bankrate.com's
Sept. 15 survey was 5.76 percent -- the lowest since March 31.
Even if the economy limps through the next couple of months and
the Fed pauses in the rate-hike campaign, the economy can lean on
low mortgage rates and continued strength in the housing market.
For more Fed coverage, including Fed
Outlook, my blog on the Federal Reserve's activities, go to
Bankrate's Fed Alert
page.
Greg McBride is Bankrate.com's senior
financial analyst.
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situation, please e-mail one of Bankrate.com's
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