Federal Reserve keeps rates steady

Sep. 21, 2006. 01:00 AM

ROS KRASNY

REUTERS NEWS AGENCY

U.S. interest rate futures dealers continue to favour rate cuts from the Federal Reserve Board to start in early 2007, although the outcome of yesterday’s policy-setting meeting was not as dovish as some had hoped.

The Federal Open Market Committee left rates unchanged at 5.25 per cent and made only minor revisions to its habitual post-meeting statement. Going into the meeting, some dealers were hoping the Fed would comment more decisively on slowing inflation and moderating economic growth to set the stage for a rate cut within the next few months. “The Fed stood true to the words of Fed officials who have spoken recently and made it clear that their bias is still, if anything, toward tightening,” said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Conn.

Interest Rate Update

Excerpts from HSH Associates newsletter for week ending September 15, 2006:

There are some signs that inflation has begun to moderate. The latest report covering the Consumer Price Index was actually somewhat better than expected, with headline CPI rising by only 0.2% for August. Stripping out food and energy costs, the so-called ‘core CPI’ edged higher by a like amount. Over the past year, the annualized rate for headline CPI is 3.8% and core, 2.8%. While those numbers are still thought to be rather above the Fed’s preferred levels, they represent a falloff from annualized figures over the past few months (4.3% in June, 4.2% in July), and the pattern does seem to be one of gentle decline.

On balance, the economy is slowing slightly and seems to be pushing inflation gently in the right direction. With slower growth, though, comes a bit of a problem for the Fed. Confounding their hope for weaker growth are lower interest rates, engineered not by the Fed but the markets themselves. In recent weeks, mortgage rates have backed off their highs by almost a half-percentage point, and applications for refinancing — stronger than you might think, given the levels of interest rates — have picked up again, as borrowers seek to trade in poor-performing ARMs and look to recast balance sheets.

Falling gasoline prices may add fuel to the fire as well. High prices work much like a tax, removing money from consumer wallets and funneling them in into a narrow economic channel. With prices sliding by maybe 50 cents a gallon in some markets, that could produce many millions of dollars of new spending in a hurry, flaring both growth and inflation higher at a time when a gentler trend would probably be more welcomed.

It’s with this backdrop that the Fed meets. So far, their plans and forecasts seem to have largely worked out, and there has been little news since the last meeting which should make the Fed feel compelled to move interest rates. Inflation does still remain a problem, though, and even if the trend is mildly downward for the moment, the Fed probably won’t feel that it has any breathing room until it’s much closer to 2% than the 3% we’re hanging near. So, we’ll get a second pause come the close of Wednesday’s meeting, but we’re still of the opinion that another quarter-percentage point move may come yet this fall. Will the committee change the statement to allude to such potential? We’ll see.