Minutes Show FOMC Worried Low Rates Could Boost Speculation

Publically, the Federal Reserve has been consistently on-message with its assertion that interest rates will remain low for “an extended period”. Fed Chairman Ben Bernanke has used this expression several times in recent communications, while Federal Reserve Bank of St. Louis President James Bullard went so far last week as to say that it could be 2012 before the Fed makes any meaningful hikes to interest rates.

Despite assurances that interest rates are destined to remain ultra-low for the near future, a quick reading of the FOMC minutes from the November meeting shows that the Fed is still keeping a close eye for possible “negative side effects” of its interest rate policy. In particular, the Fed is considering “the possibility that such a policy stance (i.e. low interest rates) could lead to excessive risk-taking in financial markets or an unanchoring of inflation expectations”.

While the minutes suggest that the probability of excessive speculation arising from the near-zero interest rates is “relatively low”, the Fed did feel it necessary to send a message to the “hawks” who worry that inflation will be the next crisis. The minutes did not layout the exact inflation conditions that would trigger a rate hike, but based on the Fed’s public stance, it is safe to say that rampant inflation is not currently seen as a realistic threat. Throw in the fact that employment remains a major concern, and the possibility of inflation requiring interest rate corrective action next year becomes even more remote.

Speaking of employment – which along with price stability comprises the two mandated areas of responsibility for the Federal Reserve – the Fed minutes revised slightly, the earlier unemployment projections for 2010. The Fed now expects unemployment to fall within a range of 9.3 percent to 9.7 percent by the end of next year, compared to an earlier estimate of 9.5 percent to 9.8 percent. The current unemployment rate as of October is 10.2 percent so the Fed is expecting some improvement on the employment front.

Another key point addressed in the FOMC minutes is the difficulty small business and individuals still face in securing credit. Despite an overall easing of capital in the financial markets, the minutes note that “financing conditions differed for large and small firms” and it is mostly the large companies that are able to take advantage of the improving credit conditions.

Indeed, access to credit remains the fly in the Fed’s ointment, and until credit can be more equally directed at these smaller firms, it will be difficult for the Fed to foster an environment better capable of expanding the job market. This could well be the area for which the Fed comes under attack as more than 7 million jobs have been lost since the beginning of 2008, and while the rate of jobs being lost has slowed in recent weeks, there is no expectation that the trend will reverse any time soon.

Quite frankly, I find the Fed’s employment projections for the end of next year to be a bit of a stretch. If in fact the rate does fall to the range put forward by the Fed, I think it will be mostly due to the fact that those unemployed for more than six months are no longer included in the count.

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