Additional Rate Cuts by the Fed Viewed as Unlikely

June 14, 2009 - In a backdrop of mounting problems which include the housing crisis, the credit crunch, in addition to skyrocketing fuel and food prices and the destabilizing impact this has all placed on the financial markets, the Fed’s balancing act has become increasingly more complicated.  The Fed has found itself in the unenviable position of having to support a continually weakening economy without further igniting inflation.  The aggressive rate cutting measures already taken by the Fed have led to a lower U.S. dollar which in turn has fueled a rise in consumer prices by increasing the prices of imported goods.  Rising fuel costs are widely perceived to pose a growing threat to U.S. economic growth.  While the Fed acknowledges that the dollar’s impact on rising commodities prices is real, it still believes there are global conditions relative to supply and demand which have been more influential in sparking the rise in fuel costs as well as other escalating commodities prices.  However it is precisely due to the growing concern about inflation that the Fed’s rate cutting process may be at an end and in fact may soon begin to reverse course. 

The real possibility that commodities prices will continue to rise is a risk that must be addressed in the inflation forecast.  Consumer’s expectations of inflation are critically important to the overall economy as purchasing habits are directly impacted by the perception of where inflation is headed.  Fortunately fears of a 1970’s type of inflationary wage-price spiral are believed to be unwarranted as the inflation rate has averaged just 3.5% during the period of the last four quarters.  While this rate of inflation may be higher than the Fed would prefer, it remains a far cry from the scary double digit rates of inflation in the mid-1970’s.  Therefore the consensus is that the Fed will choose to keep rates on hold at their next meeting on June 24th-25th and will likely decide to leave rates untouched through the remainder of the year.  It may be the perception of the Fed that by keeping rates at their current level they will succeed at accomplishing their primary goal of supporting growth without sparking inflation. 

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