Interest and Inflation

Per the Bureau of Labor Statistics, the rate of inflation in the prices of consumer goods and services was roughly 4.5% from December of 1996 to December of 1997. Yet the Federal Reserve, which up until a few months ago was mightily concerned about such inflation, has now set its federal funds rate target at 3.5%.

The Fed publicly stated last week that it expected "inflation to moderate in coming quarters". Given the extent to which the dollar has sunk in value relative to most major, if not all, global currencies so far this century, in no small part thanks to the Fed itself, one must contemplate just how much this newfound indifference to inflation will continue.

In the near term, the Fed may be able to keep short rates low, with another rate cut expected this week to be announced after the FOMC meeting. But eventually those rates should start to creep up.

So what does this mean for you? If perhaps you are considering seeking debt financing, between now and June may be the time to lock in a decent rate before the Fed is forced to do the obvious and begin to raise the fed funds target rate to deal with inflation and the continuing weakness in the dollar. But be mindful that we might be headed into an economic slowdown in which emergency Fed actions and dead cat bounces in the equity markets can mask no longer.

The Fed forestalls the inevitable

The Federal Open Market Committee announced prior to today's market open that it had lowered its federal funds target by three-quarters of a percent, or 75 basis points, to 3.50%.

This certainly feels like the house extending a drunk casino patron more credit after they've already burned through their last two extensions.

Anyways, naturally the dollar continues its slide, though no matter how low it goes, it's still cheaper to manufacture products in China or provide services in India. One also has to wonder how long the Chinese will continue to subsidize the United States with its willingness to plow the dollars sent its way back into US government debt, thereby helping to keep interest rates low. For how long will the Chinese government be able or willing to continue this arrangement? Yes, it has brought tremendous growth to the Chinese economy, but at some point one would have to think that the Chinese people will have had enough of the fruits of their labor not being reinvested in their own homeland.

The American consumer now stands on the precipice. Saddled by debt, their home values in decline, and now their equity market wealth slowly disappearing. Not to mention that the vast majority of their assets are in...dollars.

It's also interesting to note that the Fed seems almost entirely focused on making life easier for Wall Street. Of course, given that Main Street's fortunes are so closely tied to it, perhaps it's not that surprising.

Fed Lowers Rate Target. Time to Pop the Cork?

Yesterday afternoon, the Federal Open Market Committee did what was not expected, if you paid any attention to published reports, yet what was already priced in by the futures markets and lowered its target for the federal funds rate by 50 basis points to 4.75%. While US equity markets reacted favorably to the news, with the Dow Jones Industrial Average, Nasdaq Composite, and S&P 500 indices all up on the news today, it is unclear as to whether this is a sign of good things to come, as the equity market reaction seems to suggest, or merely an attempt to forestall an inevitable slowdown of the US economy. The Fed, for its part, couched its change as a response to the current troubles which have hit the credit markets, in particular mortgage lending:

"Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time."

FOMC Statement September 18, 2007

It certainly seems that the Fed is responding to pressure from the financial community to ease its monetary policy in the face of increasing difficulties in the credit markets in general, as well as to perhaps throw those who recently financed their purchase of a home with an adjustable rate mortgage a bone. Needless to say, this is probably not good news for the US dollar, which continues to depreciate in value relative to other major currencies. One does get the feeling after reading the FOMC statement that we may be headed deeper into a rough patch.