By Evelina M. Tainer, Chief Economist, Econoday
September 19, 2003

The FOMC met on Tuesday, September 16, and to no one's surprise, left rates unchanged. Their policy statement was virtually identical to August, indicating that disinflationary risks were higher than inflationary risks and that the risk of economic growth accelerating or moderating was about equal. The main difference was that the Fed noted that the labor market was weakening. They once again stated that the fed funds rate target was likely to remain unchanged for a considerable time.

Cynical bond investors suggested that the Fed threw in the comment about the weakening labor market to appease the bond market and encourage market yields to decrease somewhat. Bond investors have been more bullish about the economy than the Fed in the past several months and Treasury rates have risen substantially since their June 13 lows. The Fed needs market rates to stay down to encourage spending on interest-sensitive sectors, otherwise a 1 percent federal funds rate target has absolutely no impact on the economy.

We have already seen an upward shift in mortgage rates due to rising yields on 10-year Treasury notes. While mortgage rates remain low by historical standards, the rising rate environment will keep potential homebuyers out of the market. The Fed's federal funds rate target still has an impact on bank's prime rate and home equity loan rates. Since the 1990s, the prime rate has run about 300 basis points over the fed funds rate target. Most home equity loans are tied to the prime rate - and this has helped consumers keep down debt interest costs. Credit card companies, trying to garner market share, are also helped by the low fed funds rate. Zero interest offers have slowed (at least in my household), but low interest rates for balance transfers remain prominent offers.

Economists are predicting that the Fed won't raise the federal funds rate target until 2004. Those that are most optimistic about resurgence in the economy predict rate hikes in the first half of the year, while the more pessimistic ones are predicting rate hikes toward the end of the year.