The hands of the Fed

After raising its short-term target interest rate a quarter percentage point at each of 17 consecutive monetary-policy meetings from June 2004 through June 2006, the Federal Reserve’s policy committee hasn’t budged in a year. The interest rate banks charge each other for overnight loans has remained steady at 5.25 percent since last June. It is unlikely that the Fed will change it anytime soon.

Fears earlier this year that the deteriorating housing market could lead to a recession created the expectation that the Fed would begin a series of short-term rate cuts this fall. Despite recent evidence that the market continues to head south, those hopes for a rate cut in the next few months seemed to have been dashed by the resurgence of long-term interest rates in recent weeks, a development that many economists partly attribute to an economic rebound in the United States. After the economy expanded at an anemic rate of 0.6 percent during the first quarter (subject to revision today), the consensus view now is that second-quarter growth should reach 3 percent, perhaps higher. Moreover, even though payroll employment growth has moderated from an average monthly increase of 190,000 jobs during the second half of 2006, payroll expansion has still averaged 133,000 per month.

Meanwhile, foreign central banks have been lifting their short-term rates in the face of both strong economic growth and rising inflation overseas. The Fed has been resisting pressure to follow suit, but the still-robustly expanding global economy is putting upward pressure on long-term rates around the world. Indeed, when the Fed last convened on May 9, the benchmark 10-year Treasury note yielded 4.63 percent. Earlier this week it was fetching 5.09 percent. Over the same period, the average 30-year fixed rate for a mortgage has jumped a half-percentage point. Two other factors putting upward pressure on long-term rates may be a reluctance of Asian central banks to continue adding U.S. government debt to their reserves and a slowly evaporating “global savings glut,” which then-Fed governor (and now Fed Chairman) Ben Bernanke identified in 2005 as the principal cause of worldwide rock-bottom long-term interest rates.

Domestically, inflation signals have been mixed. On the one hand, the 12-month core consumer price index, which excludes the volatile food and energy sectors, has steadily declined from September’s worrisome level of 2.9 percent to 2.2 percent in May. On the other hand, soaring energy prices and steadily rising food prices (as a gallon of gas was approaching $3.50 at the corner Exxon, a gallon of milk was marching toward $4 in the neighborhood Safeway) pushed the latest three-month annualized rate for the overall CPI to 7 percent.

Until a clearer picture emerges, expect the Fed to continue holding pat.