Tuesday, February 19, 2008

Fed Rate Cuts Are Near an End

While many investors are betting the Fed will continue cutting interest rates, I'm starting to believe we are very near the end of this rate-cutting cycle for several reasons.

First, the Fed has already been extremely aggressive with its recent rate cuts, slashing them 225 basis points since September. Because interest rate reductions spur economic activity with a lag, the rate cuts delivered so far are probably just starting to kick in. The Fed would prefer to wait and see if more monetary stimulus is really needed.

Second, the fiscal stimulus package recently signed into law by President Bush takes a lot of heat off the Fed. While tax rebates are not as effective as tax cuts, they do give the economy a bit of a boost. This makes it much easier for Ben Bernanke and the Fed to hold off on further cuts.

Third, the stock market appears to be stabilizing. This also makes it easier for the Fed to stand pat. Bernanke was strongly criticized for reacting more to the stock market than to economic data. He no doubt is hoping stable stock prices persist.

Fourth, recent economic weakness put inflation on the back burner. But inflation cannot be ignored anymore. Any further evidence that headline inflation is creeping into the core rate will make it very difficult for the Fed to keep cutting rates.

The FOMC's next meeting is almost a month away. A lot more economic data will be released between now and then. You can bet the Fed is hoping that more rate cuts will not be needed.