The Federal Open Market Committee meets today. We are still some time away from an interest rate hike and can expect the Fed to say as much. But they'll need to start sharpening the rhetoric used, not just in their post-meeting statement but in other upcoming appearances and speeches as well. The change of tone should come in response to the parade of upbeat economic data, and we'll certainly get a nod to the return of job creation, however modest.
It is also time for the Fed to tweak the closely watched pledge to maintain "exceptionally low levels of the federal funds rate for an extended period." Specifically, it is time to remove the word "exceptionally."
Doing so acknowledges that an interest rate hike is inevitable but that even once the Fed begins to raise short-term rates, they'll still be low "for an extended period." This is also accomplished without committing the Fed to a timetable, which they certainly don't want.
What is the impact of such a change, should it occur? Initially investors will freak out, with both stock and bond prices likely to pull back. In the short-term, mortgage rates could bump up. But such an acknowledgment from the Fed would ultimately be good for mortgage rates, even if not right away.
There is a small but growing chorus, almost entirely outside the Fed, that fears the Fed will be late to raise rates with significant inflation a consequence. A good chunk of Chairman Bernanke's congressional testimony was devoted to the -- so far -- hollow promise that the Fed will fight to maintain inflation-fighting credibility by raising rates when necessary. If Bernanke is going to put his money where his mouth is, it has to start with today's statement. And once the majority of low-rate loving equity investors settle down, showing a little backbone will help keep a lid on mortgage rates even as the economy improves.
Not doing so risks the Fed looking soft, resulting in a more lasting increase in mortgage rates -- and likely much sooner.