Today the FOMC meets. Even before anyone arrived, even before any of the participants got dressed this morning, everyone pretty much knew what at this writing has not been announced: No change in the interest rates that the Fed controls; something about being vigilant about possible future inflationary risks. Everyone knows that these are the things they “must” say, partly because it is what everyone “expects.”
The days of watching news footage of Alan Greenspan crossing the street to the meeting on CNBC and gauging the possibility of rate changes from the size of his briefcase are long, long gone. In time, that story will be treated as some kind of urban legend. These days there is no need for the “briefcase indicator” because all moves are carefully and clearly telegraphed in advance. The seeds of today’s actions are in the comments from the last meeting, in the various public commentary made in public by members of the Fed, in the statements Greenspan last made to Congress. Just as surely, today’s statement will be the seed of the next meeting’s actions.
The Discount rate — the interest rate banks charge one another for overnight loans, for purposes of having the legally required amount of money on hand — sits at 1%. That is the result of June’s quarter of a percent rate cut, which was the latest in a long series of rate cuts since the beginning of the current economic troubles. As I have previously said, I believe there is a point beyond which rate cuts do not help the economy anymore (I think Japan may know something about that). Some critics even think that this cascade of rate cuts has been a borrowing from the future recovery and allowing companies that should have folded to flounder along. Under this theory, Greenspan should have let things get awful for a quarter or two and create a clear bottom which would theoretically have been over by now.
They can’t raise rates today, because that will make them look like fools for having lowered rates at their last meeting. That briefly summarizes all the esoteric reasons. A rate hike today would cause panic in the stock and bond markets, for no better reason than it’s not what they expect. However, the rate cannot linger here at 1% forever. It has to go up at some point. It has to go up because of certain discrepancies in the bond market and the money supply. It has to go up because we are outside the band where low interest rates make banks money. It has to go up because senior citizens are a powerful lobby in Washington that can influence the people who hired the FOMC members, and many of them live off interest. It has to go up because people have already gotten to the point where they don’t buy a new car without some kind of special deal.
And that brings us to the second thing the Fed will say this afternoon: be on the lookout for inflation. Alternatively, they may indulge in some Greenspeak to the effect of “balanced risks” to the economy. Inflation is the official reason to raise interest rates. Higher interest rates theoretically make it more expensive to borrow money, which reduces the amount of money companies spend on big things — Capital Spending. However, inflation encourages people and companies to buy things that they can afford today, because it may be more expensive tomorrow. People and companies buying things stimulates the economy and results in more jobs. So some limited inflation may turn out to be a good thing.
By the end of the year a rate increase seems likely, particularly if there is the faintest hint of the “second half recovery” actually resulting in people having jobs. But don’t expect low finance rates on new cars to instantly vanish. Don’t expect your bank to start paying you more than a pittance in interest. Consider locking in your variable rate mortgage, just because it’s unlikely for rates to be this low again in 5 years. Paying down the credit cards is frankly a good idea in any economy, no matter what the Fed does. But don’t forget, a rate hike means things are getting better.
You don’t need a crystal ball to know what will happen around 2:15 PM Eastern time today.