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Bernanke’s Federal Reserve Interest Rate Indecision Meeting

Interest-Rates / US Interest Rates Aug 18, 2009 - 08:40 AM GMT

By: Money_and_Markets

Interest-Rates

Best Financial Markets Analysis ArticleNilus Mattive writes: Last week, the Federal Reserve held a two-day interest rate policy meeting, and nobody was surprised by their lack of action. Heck, it’s unlikely that we’re going to see a real change in their target rate for a while yet.

But I do think there were some important suggestions buried in their comments, and I want to talk about those today. Plus, I want to throw my hat into the ring on the “Will Bernanke get another term?” debate as well.


First …

What the Fed Said, Didn’t Say, and Strongly Implied

If I had to sum up the Fed’s meeting last week, the message was essentially — “We think things are looking better, but we can’t come out and say that yet. We really want to stop intervening but we’re in pretty deep and this recovery is pretty darn fragile. Umm, so yeah, we’re not sure what to do next.”

Officially, of course, the words were far more official sounding and even more convoluted.

On one hand, the Federal Open Market Committee’s official statement noted that “economic activity is leveling out” and “conditions in financial markets have improved further in recent weeks.”

On the other hand, the FOMC said “economic activity is likely to remain weak for a time” and that it will need to employ “policy actions to stabilize financial markets and institutions.”

Bernanke knows  that he's walking a major tightrope, but that doesn't mean he won't slip up.
Bernanke knows that he’s walking a major tightrope, but that doesn’t mean he won’t slip up.

Mixed messages? Just a bit, though I think there’s real cause for their uncertainty.

As I see it, things do appear to be stabilizing a bit, though there is very little hope of a major economic rebound anytime soon. Moreover, the Fed cannot continue to pour money into every nook and cranny of the economy but neither can they just stop abruptly.

Just consider the current unemployment rate … or the fact that consumer confidence was down yet again in the month of August … or that retail sales remain pressured in July, and the back-to-school shopping season is looking lousy.

Does it really feel like the economy is rebounding yet? I doubt most would say so. And does anyone think we can return to the go-go years when everyone gets a Mercedes and a McMansion? Probably not.

Apparently, the stock market finally woke up yesterday and realized all this.

All of this creates a major Catch-22 for the Fed and it will take a serious tightrope walk to get it right.

Meanwhile, Bernanke and company were quick to dismiss the recent uptick in energy and commodities by saying “substantial resource slack is likely to dampen cost pressures.”

Hmmmm. If it’s not doing so now, and they think the economy is at least bottoming out, why do they assert that “inflation will remain subdued for some time?”

Probably because they’re operating under the cover of measures like the Consumer Price Index. This past Friday the Bureau of Labor Statistics released the CPI number for July, which showed a decline of 0.2 percent before seasonal adjustment.

Look, I think the Fed knows it really needs to start putting the brakes on at least a little bit. Yet doing so carries major risk of sending the economy back into recession.

It’s the point I’ve been making since their creative policies began: Undoing all this intervention will be far more challenging than instituting it!

For now, the Fed’s first step is going to be less monkeying around in the Treasury market.

According to the release, the FOMC will finish up its initial $300 billion in Treasury purchases and then “gradually slow the pace of these transactions” with a wrap-up by October.

Make no mistake, they will continue to intervene in other areas … including with their program aimed at loosening up credit for consumers and small businesses. That program — known as the Term Asset-Backed Securities Loan Facility — was just extended from December 31 through March 31, 2010.

But How Will This Movie End? And Will Bernanke Keep His Lead Role?

The way I see it, we should all expect higher interest rates by the fall. Whether they will gradually increase or shoot higher all depends on two things:

First, how well the Fed manages its exit from the bond market. After all, the lack of artificial demand for Treasuries will naturally push prices lower and yields higher.

Second, and more importantly, how investors — particularly foreign bond holders — react to the Fed’s exit and Washington’s overall fiscal irresponsibility.

Note that it really doesn’t matter if the Fed raises its target rate at all.

In fact, that’s the political beauty of a backdoor play like “quantitative easing.” The official policy doesn’t really have to overtly change for rates to move higher.

And while I’m on the subject of politics … I would be very surprised if Ben Bernanke doesn’t get another term as the head of the Fed.

According to a recent Wall Street Journal survey of economists, nearly everyone agrees that president Obama will ask him to stay on when his term expires in January.

Most believe Bernanke has successfully steered the system away from a complete meltdown, and a transition to different Fed head could shake Wall Street’s confidence. Moreover, just the logistics of having someone new take over seems to rule out a change at the helm.

Therefore, as investors, I think we should consider how things will play out with another four years of “Gentle Ben” at the wheel.

We should also think about what higher interest rates could mean for our portfolios and our current strategies. And what a screw-up during the Fed’s high-wire act would mean for both the economy and the financial markets. Remember, poor Fed policy decisions are what created the original credit bubble in the first place!

These are certainly all things I’m considering when I make decisions in the Dividend Superstars portfolio. And I suggest you pay close attention to these developments, too.

Best wishes,

Nilus

P.S. Important reminder: On September 1, I am permanently doing away with the $39-a-year charter rate for Dividend Superstars!

However, if you subscribe now, you will get 12 monthly issues delivered to your e-mail inbox for just $39 AND a guarantee that you never pay one single penny more than that for as long as you stay with me. Click here right now for all the details.

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