Not Quite Even Money

15 December 2003


Fed Holds Interest Rates at 41-Year Lows

The decision by the Federal Reserve to keep US interest rates at their lowest levels since the Kennedy administration came as no surprise when it was announced last Tuesday. Some were surprised that the Fed's announcement retained a promise made back in August to keep rates low for a "considerable period." There should have been no surprise in that either.

This recovery may have some impressive growth figures to it, but that is a long way from saying that the economy has recovered. There are still about 2 million fewer jobs in the US than there were before the slump. The durable goods figure has only just begun to recover with one, count 'em, one month of positive data; even then, October's 3.3% increase does not wipe out September's 6.5% drop. Factory orders rose in October by 2.2%, in September 0.5% but that comes after falling in July and August by 0.4% and 0.8% respectively.

It is simply too early to start hitting the brakes. If the Fed were to give any indication that it was going to raise rates anytime in the future, the market would react by over-reacting and stocks would fall, new hires would slow and investment spending by business would turn negative again. The country just doesn't feel economically safe yet.

The Fed did say, "The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation." Read carefully, it is saying that the chance of inflation is not quite equal to that of deflation -- falling prices remain a bigger worry than rising ones (e.g. wholesale prices for November dropped a deflationary 0.3%). And with interest rates at 1.0%, the Fed has at most 4 cuts worth of weaponry left. The market doesn't quite understand how close Mr. Greenspan and the boys came to running out of ammunition this time around.

Indeed, the Fed just might want to let inflation run a bit in 2004 to make very certain that when it does come time to tighten -- and that day will eventually arrive -- there is a gentle slowing of the rate of growth instead of a violent halt. That would make Mr. Bush happy as well; the election is 11 months away.

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