Tuesday's statement from the Federal Reserve is another in a series of very significant communications. At the extreme, it could mean the Fed is done cutting rates, barring any more massive credit-market upheavals.
A more moderate interpretation is that the Fed is back to balancing the risks between inflation and weak economic growth. Let me explain.
Fed policy during the credit crunch can be divided into the following segments:
- Before the SIVs hit the fan, the Fed was pretty much in neutral at 5.25.
- When credit markets tanked in August, the Fed used a gradual approach to cutting rates, balancing its dual mandate to keep inflation low and employment high. That led it back and forth between cutting, stopping and cutting. The cuts were mostly small and reluctant.
- In January, when markets went totally haywire and the job market weakened noticeably, the Fed stopped balancing risks and prioritized them. Growth and the credit problem took first place. Inflation was demoted. Cuts were done with a cleaver, in big increments.
Now, a big fat paragraph on inflation smack in the middle of the fed policy statement says, "Inflation has been elevated, and some indicators of inflation expectations have risen." And two voting members dissented.
So inflation just got promoted. The Fed might be back to balancing risks again.
Like I said, at the extreme, the Fed could be done cutting for a while. A more moderate approach would suggest cuts in quarter-point increments, not 50s or 75s.
All bets would be off if there was another Bear Stearns-like flare-up in the banking system. But it's clear: the Fed from now on would like to do less rate cutting. Maybe a whole lot less.