investing

Will the Fed make a move?

Since the last meeting of the Federal Open Market Committee Aug. 7, much has changed.

The credit crunch of mid-August was a global crisis that is still producing aftershocks in financial markets around the world. The Fed had to inject liquidity -- to the tune of tens of billions of
dollars -- into U.S. financial markets in an effort to get credit flowing and ease any resulting bottleneck. Further, the Fed cut the discount rate charged to banks that borrow from the Fed and took the significant step of revising its risk assessment on the economy a scant 10 days after their previous meeting. And to top it off, the August employment report caught everyone by surprise by being downright ugly, including sharp downward revisions to the June and July job growth figures that had been held up as a sign of economic vitality.

Rate types
Discount rate:
Interest rate charged to banks by the Federal Reserve
Fed funds rate:
Interest rate charged to banks by other banks
Prime rate:
Interest rate charged to best customers by banks

So while the Aug. 7 Fed meeting was a ho-hum affair, as has been the case throughout 2007, the Sept. 18 meeting will be anything but. With the economy suddenly at risk of a sharper deceleration due to the fallout from the housing/mortgage/credit markets mess, both Wall Street and Main Street are once again tuned in to the Fed.

How will the Fed respond?
Likely not with action as aggressive as many are hoping for. But the Fed isn't out to lunch either. While the Fed has explicitly stated that it is not its role to bail out bad decisions by investors, lenders and, yes, borrowers, it can't let a tough-love policy undermine the overall economy.

As a result, when the Fed statement is released Tuesday at 2:15 p.m. EST, I expect that we'll see a quarter-point reduction in interest rates.

Will this cure the ills of the housing, mortgage and credit markets? Certainly not.
Will this give Wall Street a reason to party like it's 1999? Doubtful.
Does this significantly lighten the load for debt-burdened consumers? Nope.

So what is the point? Plenty. For the Fed, a quarter-point rate cut at this juncture is an insurance policy against falling hopelessly behind the curve. It buys the Fed some valuable time to pore over economic data and take the temperature of the economy between now and the conclusion of its next meeting Oct. 31. It doesn't contradict the tough-love stance against speculation and ignorance of risk in the housing and credit markets, as Wall Street is clamoring for a half-point cut. And a quarter-point cut isn't by itself going to open the door to inflation.

With the Fed having little wiggle room on inflation, and the economy alternately showing signs of strength and evidence of weakening, a slow, methodical, deliberate approach to monetary policy is what we'll see. If only homebuyers, mortgage lenders and yield-hungry investors had taken the same slow, methodical, deliberate approach, we wouldn't be in this pickle, would we?

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