The Fed Makes the Right Call

The Fed voted to leave interest rates unchanged. The decision was unanimous.

Given that the Federal Open Market Committee backed away from its hawkish stance on inflation, the statement will be viewed by some as befuddling. However, it is questionable how much lowering interest rates further will help right now.

Hubris and outright delusion by some CEOs over the health of their companies is what got us into the current situation. The positive impact of lower rates beyond improved investors’ psyche is limited. After all, the credit crunch is being fueled by a lack of trust of borrowers by lenders, not a high Fed Funds rate.

The immediate reaction by traders was a tantrum. Stocks recovered from the initial knee-jerk reaction, however, and closed with a gain.

Part of the reason for the late afternoon rebound was the realization that the Fed left the door wide open for future interest rates. Specifically, the committee stopped saying that "some indicators of inflation expectations have been elevated." Even the inflation hawks are admitting that the commodity bubble is deflating and that the real risk is the weakening world economy.

Nonetheless, today’s decision was a non-event for financial firms such as Comerica (CMA - Analyst Report), National City (NCC) and Washington Mutual (WM - Analyst Report). Lower interest rates are not going to solve their problems with bad debt, nor reverse the fact that they originated mortgages that should have never been made.

Investors should keep in mind that the Fed has other options besides interest rates adjustments to help the economy. For example, the Fed actively brokered the Lehman (LEH) negotiations over the weekend. It has also injected liquidity and changed collateral requirements.

Most importantly, today’s decision allows to the Fed to announce a surprise rate cut between now and the late October meeting, should such a move be warranted.

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