Sometimes words are more important than deeds.
Nobody expects the Federal Reserves Open Market Committee to do anything about interest rates at its meeting today, November 4. It can’t cut short-term interest rates since they’re effectively at 0%. And they can’t raise interest rates with unemployment stubbornly high and headed to 10%.
But the committee will speak in a statement issued at 2:15 ET.
And all ears will be straining to hear if the Federal Reserve tips its hand at all on when it might start thinking about raising interest rates.
Here’s the key section in the last statement: “…economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
Will the Fed cut or modify the “for an extended period” language?
If it keeps it in, it means the Federal Reserve sees the economy’s weakness extending well into 2010. And that means no interest rate increases in the first half of 2010 and maybe not until 2011.
If it takes it out, it means the Federal Reserve is at least starting to think about raising interest rates. And investors and the economy can expect an increase sooner rather than later.
It’s not exactly clear how the market would react to either no change or a modification of the phase.
If the Fed leaves the phrase alone, it will reassure traders in the dollar carry trade. The dollar will stay weak and borrowed money will continue to flow into commodities, commodity stocks,and emerging markets. That would be good for stock prices, at least in the short run.
But investors might see keeping the phrase intact as a sign that the Fed sees the economy’s recovery as extremely weak. That would raise worries among investors, especially with the employment numbers set for release on Friday.
Dropping the phrase might cause some carry traders to close positions just in case the dollar starts to appreciate. And it might reassure investors worried about an anemic U.S. recovery.
I think the Fed will take the phrase out. It simply boxes the Fed in too much by ruling out any action on rates for a long time. The Fed would like the flexibility to decide when interest rates go up in response to the flow of news.
I don’t think simply dropping the phrase is going to convince traders that an interest rate increase that would damage the dollar carry trade is in the cards in the near term. And it would reassure investors and markets worried about the pace of the U.S. recovery.
We’ll know what the Fed said and what the market did by the end of the day.
