October 31

The Federal Reserve’s Open Market Committee (FOMC) delivered what financial markets widely expected today with a 0.25% (25 basis point) reduction in its important federal funds rate to 4.50%.  A basis point is 0.01%.

The federal funds rate was chopped by a more aggressive 50 basis points on September 18.  Despite comments in the Fed’s accompanying statement today, we would suggest greater than 50/50 odds of another 0.25% rate cut on December 11.

The Fed has been concerned about financial markets expecting too much in the way of additional monetary ease following the aggressive September cut.  The Fed’s accompanying statement noted its continuing concern about inflation pressures by stating, “Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation.”

Balance
The statement noted that, “the upside risks to inflation roughly balance the downside risks to growth” (emphasis added).  Few on Wall Street or Main Street America agree with that statement.  It does, however, serve the Fed in two ways. 

The Fed’s inflation concern reinforces the idea that the Fed’s primary job IS inflation containment, with the statement perhaps pacifying those who think recent actions by the Fed will soon let the “inflation toothpaste out of the tube.”  The statement also provides the Fed with greater flexibility to provide additional assistance in coming months IF financial market anxiety rises again. 

At the same time, the balancing of inflation risk versus economic slowing also provides the Fed with the ability to stay on the monetary sidelines for some time to come.  This is clearly the Fed’s first choice in coming months.

Even as the Fed moved to the balance position, it left the door open for more rate cuts in coming months by noting, “The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth” (emphasis added).

Offsets
The Fed well recognizes, as do most financial types, that the weakness in housing has yet to reach bottom.  The Fed also sees that the current strength in American manufacturing exports, tied to strong global demand and a weaker dollar, is largely offsetting the weakness in housing, especially when looking at the overall U.S. economy from a “macro” viewpoint. 

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