It looks like the Federal Reserve has finished cutting interest rates.
We’ll know for sure Wednesday afternoon, after the Fed’s Open Market Committee wraps up a two-day meeting. That’s when the Fed will decide whether to drop the federal funds rate (also known as the overnight lending rate) by another quarter of a percentage point or to stand pat.
Observers think the Fed will stand pat, leaving its target for the federal funds rate at 1.75 percent. That’s the consensus following Fed Chairman Alan Greenspan’s testimony Thursday before the Senate Budget Committee.
The Fed’s actions affect consumers because the overnight rate affects the prime rate, which is what banks charge their best corporate customers. You’re not going to get a loan at the prime rate, but the rates you pay on some types of debt are based upon the prime rate. Many variable-rate credit cards, car loans and home equity lines of credit are tied to the prime rate.
Right now the prime rate is 4.75 percent. If the Fed cuts the overnight lending rate, the prime rate would follow within a day or two, dropping to 4.5 percent. It’s possible that holders of some variable-rate cards wouldn’t see a drop in their interest rates until the April billing cycle; other rates might respond quicker.
But it looks like the Fed won’t cut the overnight rate, ending a string of 11 rate cuts in 2001 that brought the overnight rate down from 6.5 percent to 1.75 percent.
Just a week ago, economists and investors were convinced that the Fed would cut rates one more time because that’s what Greenspan seemed to imply in a Jan. 11 speech in San Francisco. In that speech, he said: “The long-run picture remains bright,” but added in almost the same breath that “we continue to face significant risks in the near term.”
Analysts listened to Greenspan, then closed their office doors, slew goats and examined the entrails to divine the meaning of the chairman’s remarks. They concluded that Greenspan was hinting that the Fed would cut rates one more time.
Maybe they should have read tea leaves or consulted the stars instead, because 13 days later, Greenspan told the Senate that he hadn’t been understood on Jan. 11. He said he had been trying to say, without sounding too optimistic, that the worst of the recession seemed to have passed.
“That created, unfortunately, phraseology — which, in retrospect, I should have done differently — that implied I didn’t think the economy was in the process of turning, and I tried to rectify that in today’s remarks,” he said in response to a senator’s question.
In his remarks to the Senate, Greenspan also noted that the economy “went through a significant cyclical adjustment in 2001” made worse by the Sept. 11 attacks and slowing economies among our trading partners.
“But there have been signs recently that some of the forces that have been restraining the economy over the past year are starting to diminish and that activity is beginning to firm,” Greenspan added.
Later, he said low mortgage rates in 2001 prevented the recession from getting deeper. Low mortgage rates encouraged people to build new houses, buy existing houses and tap their equity to buy things.
It seemed that Greenspan is satisfied with where interest rates are for now.
“I think that they probably won’t cut rates anymore,” says Sherry Cooper, global economic strategist for Harris Bank in Chicago and the Bank of Montreal. “Until this week I would have suggested they’ll go one more time. But it sounds like they’re trying to telegraph that the rate-cutting cycle is over.”
No matter what the Fed does, it probably won’t have much of an effect on the rates for 30-year and 15-year mortgages, says Doug Duncan, chief economist for the Mortgage Bankers Association.
“We see in the first half of the year that the 30-year mortgage rate will be in the 7- to 7.1-percent range, and as the recovery takes hold, they’ll go a little higher,” he says, adding that he doesn’t expect them to go much higher.
The effect of Greenspan’s testimony showed up immediately at the Chicago Board of Trade’s market in federal funds futures. Before Greenspan spoke to Congress, the futures market had priced in a February federal funds rate of 1.7 percent, implying a 20-percent chance that the Fed would cut the rate to 1.5 percent on Jan. 30. After Greenspan’s speech, the futures market priced in a rate of 1.725 percent in February, implying just a 10-percent chance that the Fed would cut the rate to 1.5 percent.
The Fed’s open market committee schedules eight meetings a year. Its next scheduled meeting is March 19.