Fed plays the waiting game

October 24, 2012

| MoneyRates.com Senior Financial Analyst, CFA

The Federal Reserve's Open Market Committee wrapped up its meeting on October 24 with no change to its interest rate policies. Citing concerns over slow economic growth, the Fed announced that it would continue to keep short-term rates near zero, and steadily buy mortgage-backed securities in an attempt to push long-term rates (and in particular, mortgage rates) lower.

Despite there being no change in policy, there was some information to be gleaned from the Fed's statement regarding the meeting. Here are some highlights:

1. Recent signs of inflation will be ignored -- for now

The Fed's low interest rate policies are predicated on the idea that sluggish growth is a bigger problem than inflation. The Fed frequently describes its mandate as a balance between nurturing growth and fighting inflation. Low interest rates are used to stimulate growth, while raising interest rates can be a tactic for fighting inflation. Despite a sharp upturn in the inflation rate over the past two months, the Fed still expects inflation to remain at or below 2 percent.

While the Fed acknowledges that higher fuel prices have pushed inflation higher recently, it expects that pressure to ease before long. The months ahead will determine whether the Fed is right and inflation does subside, or whether inflation becomes persistent enough to change the Fed's interest rate stance. In the meantime, it is the worst of both worlds for savers: no increase in savings account interest rates while rising prices erode the value of deposits.

2. The wrong sector is driving growth

The Fed's meeting notes mention that household spending has picked up speed, while business fixed investment has slowed. That's unfortunate. In the long run, it's important to have consumers spending because they represent the largest share of the economy. For the time being though, businesses generally have stronger balance sheets than consumers, and it will take business investment to create the jobs that will allow consumers to sustain their spending. Otherwise, the risk is that recent growth has been driven primarily by consumers going deeper into debt.

3. The Fed is focused on job growth, not just the unemployment rate

The most recent employment report represented something of a mixed message -- a surprisingly good drop in the unemployment rate despite lackluster job growth in September. Clearly, the Fed was not impressed, noting only that unemployment remains elevated. Its caution is probably wise. The unemployment rate can be subject to some statistical oddities, while consistently strong job growth would be a surer sign that the economy is recovering. In three years since the end of the recession, the economy has yet to put together a sustained streak of strong job growth numbers.

Given the persistent sluggishness of the U.S. economy and a variety of global difficulties, the Fed has good reason to be concerned about the growth prospects for the economy. But whether it has adopted the right policies to address that problem remains to be seen.

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