Federal Reserve & Interest Rates

The Federal reserve Board of Governors approved a new plan to “help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress.” This arrangement, called the Term Auction Facility (TAF), along with Foreign Exchange swap lines, is set to take effect Monday, December 17th.

“Each TAF auction will be for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). The first TAF auction of $20 billion is scheduled for Monday, December 17, with settlement on Thursday, December 20; this auction will provide 28-day term funds, maturing Thursday, January 17, 2008. The second auction of up to $20 billion is scheduled for Thursday, December 20, with settlement on Thursday, December 27; this auction will provide 35-day funds, maturing Thursday, January 31, 2008.”

According to the press release, third and fourth auctions are planned for mid January and January 28, 2008. Bids will be submitted by depositories through their local Reserve Banks. The minimum bid rate is to be figured at the OIS, overnight indexed swap, rate relative to the maturity of the credit being auctioned.

The Bank of Canada, the Bank of England, the Swiss National Bank, and the European Central Bank are all involved in the effort to address the elevated pressures in short-term funding markets. The U.S. Federal Reserve has arranged for FOREX swap lines with the European Central Bank and the Swiss National Bank. Basically, securities can be used as collateral for liquid funds for lending purposes.

The swap lines are approved for six months, tentatively.

The mortgage problem is expected to only get worse. Another 500,000-700,000 foreclosures are anticipated. If the value of homes drops more than 30%, there could be more than 20 million homeowners with negative equity.

Recession is still a looming fear. It is time to buckle down on spending, pay back as much debt as possible, and hold on tight. It is going to be a bumpy ride in 2008.

Everyone has been waiting for the Federal Open Market Committee to confirm the rate cut.  It hasn’t truly been a question of whether or not a rate cut would happen, but a matter of how much.  The FOMC did choose a modest 25 basis point reduction, making the federal funds rate 4 ¼ percent.

It is no secret that the economy is really slowing down.  The housing correction is definitely being reflected in the greater economy.  There has been some strain in the financial markets recently as well.  The FOMC made the additional rate cut at today’s meeting with the hopes that this action, along with previous actions will promote moderate growth over time.

According to the Fed’s statement, inflation remains a concern.  While readings on inflation for the year have improved modestly, commodity and energy prices might drive it up again.  The FOMC intends to keep a close eye on the situation.

What does this mean for consumers?

Overtime, the reduction in rates will help the average person save on interest.  Revolving credit card balances, mortgage interest rates and other consumer debts will accumulate less interest.  Minimum payments may remain the same in some cases, but with less interest total debts can be paid off in less time, saving thousands of dollars.  Many companies are giving special lower interest offers as a result of the rate cut, however, accumulating more debt is not a wise thing to do with the risks of recession so high.

The greatest impact will be the rates that banks charge one another for various transactions.  By lowering the amount that banks have to pay, there is therefore more liquidity in the overall financial system.  This helps the financial markets as well.  It is this liquidity that adds to the amount that banks are able to lend consumers, and as I just mentioned, allows for very slightly lower interest rates.

Has the outlook changed?

A positive outlook tailed the October rate cuts, and the FOMC seemed confident that they had made sufficient moves to pull the economy through.  Inflation remained a concern, as did the mortgage lending problems.  The markets seemed to be doing well, for a short while, and the Fed thought that they would not need to make any further actions this year to stave off recession.  According to the press release, “Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation.”

Our fluctuating economy has made it very difficult to pinpoint where we are headed.  Some say we are diving head-first into a recession, and others say we are already there.  Regardless of what we want to call it, the economy is unstable.  We saw some signs of improvement in early November, but the fact of the matter is things will get worse before they get better.  Overall consumer confidence has weakened, the dollar is weak, and credit is getting tighter by the minute.  Hopefully the rate cuts will provide eventual relief.

The Federal Reserve Board is doing everything within their power to prevent a major depression.  It is not an easy job, but someone has to do it.

The November employment data is in. Overall, the information is positive, which dampens hopes for rate cuts on Tuesday at the next Federal Open Market Committee.

According to the Labor Department payroll report there were 94,000 jobs added during the month of November. A good portion of the job increase was in retail, which contributed 24,000 jobs (understandable for the common holiday staff increase in stores). Unemployment was expected to rise, but instead held at 4.7%. Hourly earnings increased by 0.5%, which is higher than expected.

On Wall Street, the Dow was up 5.69 points at the week’s close. The Dow Jones Transportation Average rose 1.81%. U.S. supplies of gasoline are looking good, and the price per barrel of crude oil lowered by $1.95. The 10-year Treasury note was down 9/32 yielding 4.051%.

Investors are pausing for the Fed to decide on cutting rates Tuesday. Positive employment data and some nice performance in the stock market might make the case for a need to cut rates a little less convincing. With the recent oil pricing relief, the outlook on inflation might more positive. There is no clear way to tell whether or not the FOMC is going to risk inflation increases by cutting rates again. The markets have been doing well for almost two weeks, and investor confidence is rising.

The positive economic data might convince the Fed to keep the rates where they are. There is always the option of cutting a quarter percentage point. A half-point cut may not be necessary, if any cut is necessary at all. The Fed might decide on a modest rate reduction. If not, they will probably wait until the end of January to make any further moves. The economy seems to be holding up since the October rate cut.

Concerns about economic slow down have not completely subsided, but it is good to hear some positive news. Recession is becoming less and less likely as time goes on. Is it possible that the cuts made this year have been enough to keep the economy from plummeting? The goal of the Federal Reserve was to at least forestall the negative affects of sub-prime mortgage lending, and a possible credit crunch. Downside risks in lending and inflation continue to be a concern, but reports this week may ease those concerns.

The Fed might make a modest cut in rates just one more time this year to ensure that things continue to go well. There is also a chance that the previous cuts might have done the trick. Wall street will be waiting for Tuesday’s decision.