Interest Rates and the Fed Inflation Target

Fed Chairman Ben Bernanke, a long-time proponent of inflation-targeting, has set a specific inflation target of 1.5% to 2% over three years in a semi-annual FOMC report to Congress. Bernanke and the Fed were thought to have set a target as low as 1% to 2% so the “new” target range gives the Fed a little more leeway on the side of interest rate cuts in the risk of inflation vs the risk of growth debate. The subtle announcement by the Fed of a specific inflation target has been overshadowed by the release of 4th quarter GDP which shows the US economy growing at a 0.6% pace. Overall the economy grew at a pace of 2.2% in 2007 vs the 2.6% rate in 2006. The language of recent statements by Fed officials indicates that the 50-point rate cuts expected at the March meeting of the FOMC can still be expected, although Fed watchers are now predicting and trading on Fed Funds futures contracts at the Chicago Board of Trade is now indicating an expected floor of 2.00% on the Fed Funds rate (currently at 3.00%) before the Fed reverses its trend of lowering interest rates.

Investors looking to park their cash during this cycle of economic slowdown and low interest rates can expect to find more diminishing rates on bond funds, money markets, money funds, CDs, savings accounts, and other fixed-income investments. For the savings-oriented investor, there are many bank deals posted at money-rates.com where investors who open an online bank account can still find 4.00%, 5.00%, and even 6.00% rates and the rates offered on US Savings Bonds have become more attractive when compared to US Treasury yields.