Fed benches itself, won't change rates
By • Bankrate.com
Wall Street is certain that the Federal Reserve will
keep short-term interest rates unchanged when the rate-setting committee
meets Jan. 27 and 28.
That certainty is most clearly expressed in
Chicago, far from New York's Wall Street. The Chicago Board of Trade's
futures market has priced in a 100 percent chance that the federal
funds rate, also known as the overnight rate, will remain 1 percent,
where it has been since June. Observers believe it is likely to
stay at 1 percent for months. "The Fed will remain on the sidelines
until late 2004," predicts Doug Duncan, chief economist for
the Mortgage Bankers Association.
How the Fed affects rates
The prime rate, which moves in lock step with the federal funds
rate, will remain at 4 percent. Rates for many auto loans, credit
cards and home equity lines of credit are pegged to the prime rate,
and they will remain largely unchanged.
Rates for 15- and 30-year mortgages don't respond
directly to short-term rates. Instead, they move up and down with
10-year Treasury yields, which in turn move up and down with Wall
Street's view of the broader economic outlook. The disappointing
employment report for December, in which the government estimated
that the economy produced just 1,000 new jobs that month, caused
Treasury yields and mortgage rates to drop, even as short-term rates
remained the same.
Members of the Fed's rate-setting Open Market Committee
have hinted for months that they don't plan to raise rates for a
while. In its post-meeting statements, the committee has been saying
since August that it can keep rates low "for a considerable
period." That has been interpreted as meaning that the Fed
will raise short-term rates eventually, but only after dropping
obvious hints for a few months.
How the Fed drops hints
Those hints will come in two forums: in Fed officials' speeches
and congressional testimony, and in changes in the wording of the
post-meeting statements. So far, the speeches have not suggested
an increase in interest rates anytime soon.
Rates are low because inflation is low, which comes
in response to rapidly improving worker productivity. Fed officials
keep hammering this point, and Roger Ferguson, vice chairman of
the Fed, even gave a lengthy
speech this month about the history of past productivity booms
and what it means for the current one.
Some economists point out that the federal budget
deficit is projected to reach $500 billion this year and get even
bigger in the future. Theoretically, that could "crowd out"
credit availability, causing interest rates to rise. The Fed has
signaled that it won't raise short-term interest rates in response
to budget deficits.
Not my job
Donald Kohn, a member of the Federal Open Market Committee, said
in a speech this month that the government deficits are "worrisome,"
and that it's a problem for Congress and the executive branch to
fix by bringing taxes and spending more closely in line. "This
is not a task for monetary policy," he said. The Fed is in
charge of monetary policy.
"Our manipulation of the overnight interest
rate helps to keep the overall economy in balance -- promoting price
stability and production at the economy's potential," Kohn
said. "Promoting savings is a job for fiscal and tax policy."
The Fed could promote savings by raising interest
rates. But Kohn said that's not the Fed's job. He wouldn't say if
his colleagues disagreed.
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