Tuesday, January 30, 2007

Up or Down?

The Fed's meeting this week will conclude with an announcement on Wednesday that it is leaving the Fed Funds rate unchanged. There's nothing particularly interesting about that. What I do find interesting, however, is the speculation about whether the Fed's next move will be up or down.

It's unusual to be in a situation where there's no clear answer to that question. A couple of months ago I was firmly in the camp of those who thought that the Fed's next move would be to reduce interest rates, since I was convinced that the economy was rapidly slowing. However, last fall's slowdown has clearly eased, and with it the pressure that I thought the Fed would feel to reduce interest rates.

On the other hand, the talk from the Fed is, naturally and explicably, focused on the threat of overly-high inflation rates, with the concomitant threat to raise interest rates if inflation so much as twitches higher.

The result of this situation is that many Fed-watchers are simply guessing that the Fed will keep interest rates constant for a long time to come. For example:
With that in mind, there is a growing sense that the Fed may keep rates at 5.25 percent for the foreseeable future, even though energy prices have retreated lately, easing some inflation concerns.

"It's going to be steady as she goes, which is essentially the Fed saying that inflation trends are lower but the risks are still to the upside," said Keith Hembre, chief economist with First American Funds in Minneapolis. "I think the Fed's on hold for the next six months."

David Kelly, senior economic adviser with Putnam Investments in Boston, goes one step further. He thinks the Fed will keep rates at 5.25 percent throughout 2007.
It strikes me as faintly absurd to guess that nothing will happen in the next 11 months that would tip the balance toward higher or lower interest rates. I still suspect that the Fed's next move will end up being toward lower rates, simply because that would be consistent with historical experience, but I don't know for sure. What I do feel quite sure of is that things won't remain just as they are for all of 2007.

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