September 16th, 2008

FOMC Meeting: Will Rates Change?



Today’s regularly-scheduled Federal Open Market Committee (FOMC) meeting will likely result in the Fed leaving short-term interest rates unchanged. The odds that the Fed will leave rates unchanged hinges on the movement of today’s market. While the FOMC meeting is set to finish in the early afternoon, a tumultuous morning could lead the Fed to reconsider. The Wall Street Journal makes the case for — and against — cutting rates:

The case for a quick rate cut: Continued market turmoil could hurt an already weak economy. Mortgage rates fell last week after the government’s takeover of mortgage giants Fannie Mae and Freddie Mac, but market turmoil could push rates up for both mortgages and other consumer loans.

The Fed has taken pre-emptive action repeatedly over the past year, cutting its interest-rate target as protection against a deeper economic downturn. The failure of Lehman, the rapid takeover of Merrill Lynch & Co. by Bank of America Corp. and continuing concerns about AIG underscored the risks.

Many Wall Street investors are essentially begging the Fed to cut interest rates to boost confidence and reduce some of the turmoil. By the end of Monday, futures markets put the odds at two out of three that the Fed would lower its benchmark federal-funds rate, currently 2%, by a quarter percentage point Tuesday. Merrill Lynch economist David Rosenberg predicted a half-point cut.

But cutting rates now would carry its own risks. It could remove some of the Fed’s flexibility in the event that the financial crisis worsens. The Fed cut rates after the market crash in 1987, when the Dow Jones Industrial Average lost almost a quarter of its value. It also eased on the first trading day after the Sept. 11, 2001, terrorist attacks.

In both cases, the potential turmoil was much clearer. But the Fed may resist taking action on Tuesday, less than two trading days after the weekend’s events, when the longer-term impact on credit costs and availability — and potential economic damage — remains far from clear.

Cutting short-term interest rates is an attempt by the Fed to pass on a lower cost of borrowing to the consumer. The current problem doesn’t reside in the cost of borrowing. It remains whether today’s consumer qualifies for the increased restrictions that stand between them and their loan. If the Fed would cut rates, it would likely only be .25%, not enough to make the impact all too many are hoping for.

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2 Responses to “FOMC Meeting: Will Rates Change?”

  1. Rebecca Wilder Says: September 16th, 2008 at 3:15 pm

    The Fed can always call an emergency meeting if things really get out of hand! I agree, it is too early to tell what will be the ramifications of Lehman and Merrill. The unemployment report will surely get a bump, but the financial system will probably work itself out. So barring any unforeseen and negative shock, the Fed is doing exactly what it needs to do – stabilize growth and prices!

  2. Tim Manni Says: September 17th, 2008 at 1:41 pm

    Rebecca — You’re right, the Fed calling an emergency meeting is certainly not out of the realm of possibility — I believe it was an emergency meeting the Fed called when they cut rates right before the Bear Stearns mess. As for unemployment, that will with out a doubt spike with financial layoffs.

    What are your thoughts on AIG?

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