There was almost no chance of any formal change to interest rates today.  Everyone has been speculating that the FOMC has been looking for an end-game away from the near-zero Fed Funds target now that the banking crisis seems to have stabilized.   The other issue traders were looking for was whether or not the Fed would stick with a “risks of deflation have subsided” or if they’d change to “risks of inflation are starting to appear.”

The Fed has previously maintained a stance that interest rates were going to remain low for some time into the future.  In short, the worry is if the U.S. will have to digest higher rates toward the end of 2009 or whether we are in an extremely low interest rate environment into 2010.

The FOMC kept rates stead at 0.00 to 0.25%.  It continues to believe economic conditions will keep rates low for some time.  It also said that despite higher commodity prices, the weak economy and a resource slack is expected to keep inflation subdued for some time.  The purchase of securities is also going to remain through the bulk of 2009.  Today’s vote was unanimous.

The FULL FOMC STATEMENT is here.  There is not a solid mention of the risk of deflation concern here, but the FOMC is sticking by the notion that no major inflation is imminent.

The general belief has been a “less-bad” scenario on behalf of the Fed.  For that matter, on everyone’s behalf.  The Fed has been noting on multiple occasions that the rate contraction was shrinking, which falls into our own notion of “lower rates of change.”

Even if the FOMC had come out said it was grossly worried about inflation, the notion that Ben Bernanke and friends would start ramping rates massively higher just seems misguided.  Imagine when the White House has even started using 10%+ as what is coming in the unemployment rate and the Fed decided to embark on a series of rapid rate hikes….. It just is not plausible.

At this point with so many suffering and hundreds of thousands or millions more in the “soon to be suffering camp,” do you think the Fed will accept 1% higher inflation down the road at the risk of another 1% to 2% more in unemployment?

Technically, unemployment is not the only target nor necessarily the top target of the FOMC.  The first goals of the FOMC listed on their mandate are “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”  It then sets out, “Stable prices in the long run are a precondition for maximum sustainable output growth and employment as well as moderate long-term interest rates.”

Bernanke and friends did the right thing today.  With oil having risen so much and with other commodity prices having risen as the US dollar fell, the FOMC knows the risks here.  Bernanke, and any other public figure, has generally found it easier to explain prices being 2% higher than they have unemployment being 2% higher and GDP being 2% lower.

Besides the notion that this at least keeps the new interest rates lower for the Treasury’s borrowing costs, the longer the Fed and Treasury can keep the yield curve relatively steep the longer they can keep the profits rolling at the banks.

Jon C. Ogg
June 24, 2009

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