I continue to argue that the Fed should stop its interest rate targeting and instead target a stable dollar instead, but Bernanke and company seem wedded to their absurd old ways. That said, I think the Fed blew it again today by keeping interest rates steady. As I argued in the past, I argue again today: Hiking the interest rates a bit, while issuing the right sort of statement, would have been the wiser course. Counterintuitively, it might have helped home mortgage interest rates FALL. How? For the same reason that cutting the Fed’s rates did NOTHING to cut the mortgage rates: because mortgage rates are set by lending companies based on their analyses of long-term trends. It does no good for shrot-term Fed rates to be low if, by virtue of being low, they boost long-term inflationary expectations — because then the mortgage lenders will want to keep their rates high so that the interest they get paid is not dwarfed by inflation in the future. Conversely, in these weird circumstances that apply today, a move by the Fed to demonstrate a real commitment to a strong, non-inflationary dollar could lessen the inflationary expectations that private actors now hold. With the inflation worries subsiding, they could allow their 30-year notes to drop in price — and there will still be PLENTY of room for them to do so even if the Fed raises its short-term rates by half a point, because that would put the Fed rate at 2 1/2 percent, which is still amazingly low.
The markets responded very well today to the Fed holding the short-term rates steady. But in very short order, I predict that fears of inflation will cause the markets to tank again — all because the Fed blew yet another opportunity.
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