The U.S. government's takeover of Fannie Mae and Freddie Mac won't change the Federal Reserve's current course for interest-rate policy. Amid a nagging credit storm and improved inflation backdrop, the Fed looks increasingly likely to keep its benchmark interest rate unchanged at 2% into next year.
A few months ago, some investors thought short-term interest rates would be moving higher by now amid mounting worries about rising oil prices and inflation. But those concerns have receded as troubles in the economy show few signs of abating, leaving Fed officials inclined at their meeting on Sept. 16 to keep rates at the same level they have been at since April.
Futures markets don't see significant odds of a rate increase until spring.
Housing remains at the center of the Fed's concerns about growth and financial stability. The Fed has pushed the federal-funds rate down 3.25 percentage points in the past year in an effort to cushion the blows of the credit crunch. But the financial system faces continued strains and a bottom in home prices is still not in sight. Despite the Fed's efforts to push interest rates lower, mortgage rates have barely budged -- staying above 6% -- as risk-averse banks tighten lending standards.
The government's rescue of Fannie Mae and Freddie Mac, the mortgage finance giants, could soften the blow. Fed Chairman Ben Bernanke played a central role advising the Treasury Department and the firms' regulator on the plan and has blessed the move.
The government's takeover of the mortgage firms, which own or guarantee half of the nation's mortgages, should make it cheaper for Fannie and Freddie to borrow. That could help nudge mortgage rates down as much as half a percentage point, by some estimates, which could bring more buyers into the housing market and help prices find a floor.
But immense uncertainties about housing linger, one factor making officials cautious about pushing interest rates higher any time soon. Home-price declines have shown glimmers of slowing in some parts of the nation, but they might have been distorted by seasonal factors. Home sales also show tentative hints of stabilizing, but could deteriorate further if credit conditions tighten.
High mortgage rates mean the Fed's rate cuts have so far failed to translate into lower borrowing costs for consumers and businesses in all the areas in which they usually do. Many Fed officials see the lingering disconnect between their own policy rate and other borrowing rates as a cue that financial conditions are tight and that they have leeway to leave their target rate low.
Much of the Fed's easing of interest rates to date 'has merely offset the tightening in credit conditions created by the financial turmoil that began last summer,' Eric Rosengren, president of the Federal Reserve Bank of Boston, said in a recent speech.
Also weighing against a shift in policy is the inflation backdrop, which has eased considerably since Fed officials last met Aug. 5. Falling commodity prices haven take steam out of food and energy inflation, while a rising jobless rate has produced slack in the labor market. A stronger dollar has also taken pressure off import prices. And a slower global economy means less global demand.
'It seems clear that inflation risks have diminished somewhat in recent months as commodity prices have come down from their high,' Janet Yellen, president of the Federal Reserve Bank of San Francisco, said in a speech last week. She added that she expects inflation to drop to a 'much more moderate rate' next year.
Officials expect economic activity to weaken in the second half of this year and only recover slowly next year. Export growth is expected to slow due to a weaker global economy. The latest jump in the U.S. unemployment rate, to 6.1% in August from 5.7% in July, underscored how conditions have deteriorated more than the Fed expected. In June, policy makers' projections for the fourth-quarter unemployment rate ranged from 5.5% to 5.8%. They will make their next forecasts in October.
Still, most officials expect the Fed's next move will be a rate increase, and not a cut. Though commodity prices have fallen, core inflation, which excludes food and energy, could continue to drift higher. Moreover, it's not clear that more rate cuts would help the economy, given that a year of cuts hasn't significantly reduced rates on mortgages and other loans.
Sudeep Reddy / Jon Hilsenrath
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