Wake Up! The Fed Is Not Going to Cut Rates

by Justin Weinger on September 14, 2007

On September 18, the Federal Reserve is going to take the unpopular stance and will announce that they have decided to leave the federal funds rate at 5.25%, where it has been for over a year.

It’s going to shock Wall Street – who apparently believes it’s a foregone conclusion that the Fed will drop rates by at least 25 basis points – and could very well cause the Dow, Nasdaq and S&P 500 to drop by five percent or more on the 18th alone.

From Day One, Ben Bernanke, the guy left to fix all of Alan Greenspan’s misguided policies, has said that his number one concern is curbing inflation – not soothing the market.

Despite the credit crunch, the United States’ economy is still moving along quite nicely. We’re still on pace for another year of at least 3% growth, even in the midst of an economy that appears to be slowing. Notice, I said “slowing,” not “coming to a grinding halt.” Regardless, the economy does not yet need the jolt that a cut (or continued cutting) in interest rates would provide.

With a barrel of oil sitting at $80 (a record high), the cost of heating our homes this winter will probably be markedly higher than last year – which was the story the previous winter, as well as the winter before that. Throw in a healthy spike in the cost of food, gasoline, and (thanks to a falling dollar) imported goods, we’re very likely to face strong inflationary pressure for months to come.

In addition to the U.S.’s economy, the world economy in general is still booming, especially in developing nations like China and India, which is probably why most of the world’s central banks are either holding interest rates steady or continuing to bump them up. In the midst of a falling dollar, Bernanke can’t start taking rates down if his counterparts aren’t going to join in the fun.

I also think that Bernanke would like to separate himself from his predecessor and let the pigs get slaughtered. Let’s face it, recession is part of the business cycle, trying to lessen, negate or do away with it could very well just create a much larger problem (i.e. a depression) down the road when all of the problems that had been swept under the rug and never dealt with all decide to pop up at once.

I know that the drop in the housing market is weighing on many of us (hell, it’s giving me an ulcer) and is probably altering our spending habits, but a cut in the federal funds rate isn’t going to solve the problem. Housing prices are just too high and have vastly outgrown wage increases over the past decade or so. The market is due for a correction. It sucks for people who bought recently (I’m in that boat), but that’s the way it goes.

Even if the Fed were to cut rates, it doesn’t necessarily mean that the housing market will bounce back or that it will even slow the market’s fall. Financial institutions need to start lending money again in order to reach the market’s bottom, but they’re not going to do that until they’re certain all of the risky debt that they’ve taken on (much to their own doing) has either been contained or shaken out of the market all together.

Unfortunately, since we’re just now entering the first big wave of mortgage rate resets, it’s going to take a lot of time for that to happen. Cutting the federal funds rate isn’t going to expedite that process.

Long story short, the Fed is going to do what it should do, and it will keep the all-important federal funds rate where it has been for the last 14 months.

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