On 12/13/05, The Federal Reserve raised the target Fed Funds rate 25 basis points to 4.25%. This widely expected move marked the 13th straight increase since June 2004.
What wasn’t as widely expected was The Fed’s decision to alter the language of its policy statement. By removing the word “accommodative”, The Fed may be hinting that interest rates are finally getting close to reaching a neutral level.
Does this mean that The Fed is finished (or close to finishing) raising interest rates? The markets sure think so. Stock and bond prices shot higher after news of The Fed’s statement. The DJIA was up 82 points at 10,850 by 3:00pm. The NASDAQ gained 9 points to reach 2,270, the S&P 500 rose 11 points to 1,271 and the yield on the benchmark 10-year Treasury held at 4.52%.
Why has The Fed’s direction been such a hotly debated issue? Keep in mind the dual mandate of economic growth and price stability. These policy goals can (and often do) conflict. Whether you’re a “glass half empty” or “glass half full” person defines your view about whether The Fed has or has not met their stated goals via interest rate hikes.
Let’s explore further…
On one hand, arguments can be made for an economy so strong that inflation (e.g. raising interest rates to promote price stability) should be the focus. Energy prices are up, home prices are up, consumer spending is strong, the unemployment rate remains low at 5%, etc.
Consumer spending is of particular interest since it represents 65%- 70% of GDP. Recent data shows an economy with traction. Last month, retail sales reached $353.9 billion – a 6.3% increase over November 2004. Retail sales (ex-autos) jumped 8.7% over the year ago period. Online shopping was up 10.3%. Finally, rebuilding efforts along the Gulf Coast drove sales of building materials 14.5% higher than the year-ago period.
On the other hand, arguments can be made for an economy where economic growth (e.g. flat or decreasing interest rates to promote economic expansion) should be the focus. Consumers are already deep into debt and can’t keep spending forever, home prices can’t keep up their meteoric rise, business investment and capital expenditure are well off historic levels, the trade deficit is at an alltime high, etc.
One thing is clear, however. The language change in the policy statement shows The Fed is more closely looking at the data and concluding that current policy may no longer be appropriate. What’s more, it’s a clear signal that shifting policy coupled with the end of the Greenspan regime (after the 1/31/06 FOMC meeting) is clearing the way for incoming Chair Ben Bernanke to carve his own policy.
So where are the markets headed as a result? We say higher.
Markets hate uncertainty. When The Fed would stop raising rates was unknown. We now know that it’s only a matter of time. Investors take notice!
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We’ll write to you again soon. Keep visiting our site for frequent updates. Keep those comments coming. We love hearing from you.