Federal Reserve & Interest Rates

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.

Investors are waiting the December meeting of the Federal Open Market Committee. Market performance has been slacking for that passed few sessions. Wall street is worrying that the housing plummet is pulling the economy down a little too far.

Tuesday’s trade ended with the DOW down by 65.84 points. The NYSE dropped by 63.48 points by Tuesday’s close. The NASDAQ slipped by 17.30 points. Traders are getting nervous about recession with the overall slack in market performance so far this week. There is much debate about the next action that the FOMC will take. We are still awaiting the November jobs report, and the next Fed meeting isn’t until next week on the 11th. Will the FOMC cut rates again this year?

There was plenty of language from the Federal Reserve Board of Governors since the last meeting that indicates that the rates will not be cut again this year. There seemed to be plenty of confidence from Chairman Bernanke and others, including the minutes from the last FOMC meeting. It seems that the Fed feels the actions taken thus far this year should keep the economy from slipping into a total recession. Economic slow down is expected, but another cut in interest or federal funds rates didn’t seem to be in the plans for the last meeting of the year.

The price of crude oil fell by $1.10, making each barrel now $88.21. While data has shown that core inflation has not been dramatically affected by the high energy prices, this is still good news. Commodity prices have certainly impacted consumer spending levels, as comparisons to spending in previous years are showing that people are not buying as much. Even if energy pricing improvements don’t help overall inflation significantly, consumer spending may improve as a result.

The last time we had drops in the financial market the FOMC cut rates. Economists and investors are all speculating about whether or not they will cut the rates one more time before the year ends. Some think they will because of the market trouble. They have already pumped finances into the system and cut the rates a few times this year. Market trouble might signal a threat of recession and a cut may be used again to forestall it. Others think that cutting rates again will just spoil the banks and traders because they will rely on rate cuts instead of investing wisely. The vibe from the Board of Governors leans more towards not cutting rates anymore this year.

In a time of economic uncertainty, things could go either way. Inflation is still a concern, and another cut in rates could make it worse. After the December 11th meeting, we will find out if action is needed. If the financial markets continue to slip, they may be a cut.

Frederic S. Miskin, member of the Federal Reserve Board of Governors gave a speech Friday discussing the financial instability of our nation and the reasoning behind actions that the Federal Reserve has taken both historically and recently.

Miskin explained e responsibility of the Federal Reserve in response to financial instability. He says, “The interest of the Federal Reserve in financial stability does not arise out of a concern for the functioning of financial markets as such or out of a desire to aid distressed investors or institutions. Rather, the Federal Reserve vigorously promotes financial stability because of the intimate connection between a stable financial system and solid macroeconomic performance. The financial system, comprising financial markets and institutions, channels funds to those individuals or firms that have productive investment opportunities.”

According to Governor Mishkin, there are four main ‘shocks’ that can at as ‘catalysts’ in financial instability.

• sharp increases in interest rates
• the deteriorating of corporate and household balance sheets
• weakened financial intermediaries
• problems in the banking sector

“Central banks typically inject liquidity into the system via the banking sector, but the intent is clearly to have the liquidity spread from there…injections of liquidity have the potential to directly address the causes of financial instability and therefore to counteract the pernicious effects of financial instability on broad macroeconomic conditions.”

He went on to discuss financial crisis in the past mentioning issues including the Panic of 1907 and the Stock Market Crash of 1987. He cited methods and examples of the efforts of the Federal Reserve to provide liquidity to the financial system.

While discussing the financial instability that currently faces our nation, Governor Mishkin stated, “Although the provision of liquidity is undoubtedly a useful tool, it is not without potential costs.” He went on to explain that this type of action might create and incentive for banks to increase the amount of investment risks that they are willing to take on. If similar actions are improperly handled, it can lead to further financial instability. The Federal Deposit Insurance Corporation Improvement Act of 1991 limits the lending ability of the Federal Reserve to troubled banks to keep that kind of moral hazard from occurring.

With all of that said, there is still a 50/50 chance that there will be another rate cut this week. The FOMC meets at the end of this month and investors and economists are still wondering what the Federal Reserve will do next. Is this speech a foreshadowing of another drop in rates as a move of the Reserve to increase financial stability? Or is Governor Mishkin saying that further moves to help the troubled markets at this time would cause moral hazard? In just a few more days we shall see if there will be any further moves.