Monday, September 22, 2008

The Fed Stands Pat Keeping Rates Unchanged for Now

by Nancy Osborne, COO of ERATE


At its September 16th meeting, the FOMC decided to keep the benchmark federal funds rate unchanged at 2% for a third consecutive time. This decision was unanimous amongst FOMC members, marking their first uncontested decision on rates in a year. Futures traders were projecting an 80% possibility of a .25 point cut by the Fed yet ironically just several months earlier they were forecasting a 100% chance of a rate increase. After a roller coaster weekend of horrific financial news snowballing from the Lehman bankruptcy filing followed by the B of A acquisition of Merrill Lynch and then the stunning collapse and government takeover of insurance titan AIG, investors and traders alike saw the odds of a cut in the key rate rapidly rising. Fed policy makers had begun their series of seven rate cuts starting in September 2007, commencing just one month after the sub-prime debacle first unfolded, and they continued with this series of rate reductions through April of 2008 when commodities prices and inflation became an overriding concern. Until that time, the Fed's aggressive rate cutting measures had pushed the federal funds rate down from 5.25% to where it stands now at 2.00%. Futures traders had recently been persuaded to believe the Fed would now ease again at its September meeting in an effort to help beleageaugered financial companies weather the storm and support the stock market which had recently suffered its worst daily slide in six years. Rate cut expectations were further supported by the gradually improving news on the inflation front, as oil prices had been gradually declining as the global economy slows. The downside risk to growth and the upside risk of inflation both remain key concerns at the Fed, however the credit crisis appears to be in large part a crisis of confidence and therefore less likely to respond to further a reduction in rates. The Fed has already been working overtime to make funds readily available, providing liquidity directly to the distressed institutions that need it most. Yet another rate cut by the Fed might have been perceived as a panic response to a crisis that is worsening when Fed officials may prefer to let the dust settle a little longer on the most recent stream of financial disasters before taking further action.

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