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So when will the Fed raise rates? The schedule gets even more confusing
02/10/2010 12:39 pm EST
That’s what global financial markets are trying to figure out this morning after Federal Reserve chairman Ben Bernanke told the Financial Services Committee of the U.S. House of Representatives that the Fed may raise the discount rate “before long” as part of its plan to exit a period of extraordinary Federal Reserve intervention in the financial markets. The discount rate interest rate target is now 0% to 0.25%.
That’s a change from the Fed’s mantra, repeated for month after month after meetings of the Federal Open Market Committee that sets interest rate target, that low rates are warranted “for an extended period.”
But it’s by no means clear if the new language means the Federal Reserve will start to raise interest rates in three months or six or nine or ….
Count on the Fed to make a murky situation even murkier. How's that possible?
Bernanke said that the Fed may temporarily, however long that might be, move away from using the discount rate, the interest rate that banks pay when they borrow funds from a Federal Reserve bank for the short term, as its interest rate target. Instead, the central bank might start paying more attention to the interest rate that it pays banks that keep money on deposit with the Federal Reserve.
That rate has taken on more importance as the Federal Reserve tries to manage the vast expansion of the money supply created by its emergency purchase of bonds and other securities from banks during the financial crisis. Banks deposited much of the cash from those sales back with the Federal Reserve. The Fed is worried that if banks suddenly withdraw that money and start turning too much of it into loans that it would lead to run-away inflation. To control the rate at which that money flows into loans, the Federal Reserve plans to raise the interest that it pays banks for their deposits.
As I understand the new system of interest rate targets that the Fed is proposing, the Fed would watch both the discount rate and the deposit interest rate and set policy by managing the spread between those rates as well as by setting the absolute levels of those rates.
All those details of how the Fed plans on managing monetary policy in the months ahead are important, no doubt, but what financial market really want to know is when the Fed will start raising U.S. interest rates.
I don’t think you can answer that question by studying the Fed’s language right now, no matter how finely you slice and dice those words.
The Fed is on hold, just like the rest of us, until it gets a clearer picture of the strength of the U.S. economic recovery. The Fed won’t move as long as it thinks raising interest rates could damage or sink the recovery. The next big indicator of strength of weakness will be first quarter GDP numbers in April.
The Fed will get to see those numbers before investors will but not tremendously earlier. Until then we all wait.
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