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Archive for Wednesday, August 13, 2003

Fed keeps interest rate steady

Greenspan, colleagues pledge low rates for ‘good long time’

August 13, 2003

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— Amid signs of economic revival, the Federal Reserve held a key short-term interest rate at a 45-year low on Tuesday and signaled its intention to keep credit easy "for a considerable period."

The action by Federal Reserve Chairman Alan Greenspan and his colleagues left the central bank's target for the federal funds rate, the interest that banks charge each other, unchanged at 1 percent, the lowest level since July 1958.

"The Fed was very clear this time. They are going to leave rates at this level for a good long time, for at least another year," said Richard Yamarone, senior economist at Argus Research in New York.

Wall Street rallied on the Fed statement, with the Dow Jones industrial average surging by 92.71 points to close at 9,310.06, extending a five-day rally.

The bellwether 10-year Treasury note, which is a key determinant of mortgage rates, ended the day at 4.43 percent, up from Monday's close of 4.36 percent.

While the Fed can directly control short-term rates, it can only indirectly influence long-term rates, which are set by financial markets.

The fear has been that a big rise in long-term rates during the past month, which has sent mortgage rates to their highest levels in a year, could derail the economic rebound just as it is getting started.

Economists said the central bank's Federal Open Market Committee was trying to clarify muddled signals it had sent at its two previous meetings. The mixed messages had first sent long-term bond yields dropping dramatically after the May meeting only to help them snap back after the June meeting.

The Fed said it was prepared to leave the short-term rate where it is for some time to come because of a belief that "an unwelcome fall in prices" poses a bigger threat to the economy right now than inflation.

The 10-year Treasury note fell to a low of 3.1 percent after the Fed for the first time spoke of a potential deflation threat in its May statement. Based on subsequent comments of Greenspan and other Fed officials, the bond market believed that the Fed was prepared not only to push the funds rate lower but also use "unconventional" methods to influence interest rates, such as buying longer-term Treasury securities.

However, at the Fed's June 25 meeting it only cut the funds rate by a quarter-point, rather than the half-point that had been expected, and there was no mention of possible use of unconventional methods to influence rates.

Since that time, long-term interest rates have risen sharply, with 30-year mortgages climbing to a one-year high of 6.43 percent last week, up from a four-decade low of 5.21 percent set in June.

Many analysts said they believe the Fed's commitment to keep short-term interest rates low for a considerable period of time will help to stabilize long-term rates.

Economist David Jones predicted that 10-year Treasuries would probably trade around 4.25 percent to 4.4 percent for the rest of the year while 30-year mortgages would settle into a range of around 6.25 percent.

David Wyss, chief economist at Standard & Poor's in New York, said while bond rates would probably stabilize for a time, the trend would still be up, given incoming data that indicates the economy is strengthening.

"If you haven't refinanced (your mortgage) do it now," Wyss said, because mortgage rates will likely only be heading higher from this point.

"Yields will be trending higher, but that will be a reflection of a stronger economy and that is good news," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.

The Fed's decision to hold rates unchanged was taken on a unanimous 12-0 vote. In June, Robert T. Parry, president of the San Francisco Fed, had dissented, saying he preferred a bigger half-point rate cut at that time.

The Fed has trimmed its federal funds rate 13 times since it began an aggressive easing campaign in January 2001 as it tried to cushion the impact of a bursting stock market bubble, followed by a recession, terrorist attacks, a wave of corporate accounting scandals and economic jitters before the Iraq war.

In its statement Tuesday, the central bank expressed optimism that its continued low interest rates along with strong productivity growth would provide "important ongoing support for economic activity."

While noting that spending had rebounded somewhat since the last meeting, labor markets remained mixed. The unemployment rate fell to 6.2 percent in July, from a nine-year high of 6.4 percent in June, but businesses slashed payrolls for a sixth straight month.

Assessing the various indicators, the Fed panel said it believed the "upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal."

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