Art, we had very long periods of inflation in the 1% to 2% in history. Historically, long term interest rates were about 2.5% to 3.5% above the inflationary "trend line". To some, inflation of 3.5% is high. Not so much because by itself it is a big number, but because it builds in the investment community expectations of additional more rapid inflation in the future. Right now with the Fed rate at 6.5%, the interest rates are not excessively tight, and with treasuries, for various reasons much lower than that, the relatively high interest rate at the Fed's window does not really inhibits growth by itself. What might inhibit growth is the lack of lending to less than very worthy borrowers. Lowering the rate right now, will allow banks to increase their spreads and repair damage caused by non performing loans on their balance sheet. However, a side effect of lowering rates right now, would also, possibly be, a reignition of "irrational exuberance". That the fed's must avoid. Thus is they can talk the markets out of a very damaging catastrophic and rapid decline without actually lowering the rate (by telling everyone they are concerned about growth, but not by "doing" anything about it), they may achieve their goal of a "soft landing". A soft landing is not only relating to the economy not going into two consecutive quarters of negative growth (a recession), but it is also the "orderly" readjustment of financial assets value to more normal measures. Financial assets is where inflation is really present, and the Fed's would want to see the bubble deflate gradually, rather than in a single one week crash. How far will they want the Naz to go? I wish I knew, but their own model still has equities too high relative to treasuries.
Now, I am not saying that the feds are right or wrong, all I am trying to do is to try and understand their own "motives" so as to assess and guess their next move. In view of what I just said, I doubt the fed's are going to lower rates in the next FOMC meeting (late January), particularly if in the interim we have a "year end rally" and an early January rally. They'll talk about it, but that is it.
Things would be different if a financial accident were to occur, since the Fed hates financial dislocations (and these are truly damaging if not managed correctly) even more than inflation. Thus a major crisis in Asia, or the default of a number of companies on debt in excess of $100 B or so (like CA utilities), or even a sudden market crash (which they are trying to avoid), would all be good excuses to rapidly lower interest rates. You must understand that they are reluctant to use the weapon of lowering rates for just a slow down in the growth rate from 5% to 2% or so, because that spends up the ammunition they always have to have on hand in the event of a financial accident. Japan kept lowering rates until they became negative, but without implementing additional measures in their economy, it was like pushing on a rope, it did not work. The Feds do not want to be in a position where they have lowered rates, mostly for political reasons, so low that if an exogenous event actually requires lowering rates as a Fed intervention, such lowering is no longer effective since the rates are already low.
Zeev |
