Is a Rate Cut On the Way? Decoding the Fed Chairman’s Speech

Federal Reserve Chairman Ben Bernanke gave a speech Monday on the Fed’s recent and future moves — and current take on the economy. Some highlights of his talk, given to the New York Economic Club: The housing decline isn’t over and will likely continue through 2008, dragging down growth. The mortgage sector still

Federal Reserve Chairman Ben Bernanke gave a speech Monday on the Fed’s recent and future moves — and current take on the economy.

Some highlights of his talk, given to the New York Economic Club:

  • The housing decline isn’t over and will likely continue through 2008, dragging down growth.
  • The mortgage sector still has room for improvement.
  • We’re not sure yet if rising credit costs will affect consumer spending.
  • Bernanke viewed mid-August as a low point for the financial markets.
  • U.S. economic performance so far this year has been "reasonably good."

So what’s next?

It’s unclear if the Fed will or won’t offer another rate cut this year, but Bernanke’s comments offered some insight as to what direction the Fed is heading.

The Fed had previously this year, while recognizing the growing housing problem, remained optimistic about it not crippling the economy — in August, the Fed said it would hold its target for the federal funds rate steady because "although the downside risks to growth have increased somewhat, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected."

However, now the outlook isn’t so rosy.

Bernanke said Monday that the financial market turmoil has "significantly affected the Committee’s outlook for the broader economy."

Bernanke stressed the importance of using policy as a preventative measure — the first ah-ha moment in his speech. Could that indicate the Fed is considering another cut?

Consider his comment about the current state of the economy:

"Since the September meeting, the incoming data have borne out the Committee’s expectations of further weakening in the housing market, as sales have fallen further and new residential construction has continued to decline rapidly," Bernanke said. "The further contraction in housing is likely to be a significant drag on growth in the current quarter and through early next year."

We all agree that’s not good. But is it bad enough to prompt another cut?

We’ll need to watch the following factors to decide — which is what the Fed says it will be doing, too:

  • Household and business spending. The Fed doesn’t want either to fall. If either does, it indicates growth is slowing.

Rate cut translation: Maybe we won’t offer a rate cut. Bernanke stressed through his speech that growth seemed OK.

  • Housing market data. The Fed is concerned about increasingly difficult credit situations that may result from the housing market decline. Despite earlier this year placing more concern on inflation than the slump, the Fed now worried about the housing decline’s effect on overall growth.

Rate cut translation: Maybe we will offer a rate cut. As expected, "sales have fallen further and new residential construction has continued to decline rapidly," Bernanke said. But just because the Fed anticipated it doesn’t mean they’re happy about it.

  • Employment and labor income. If labor income rises, it is expected consumer spending will as well.

Rate cut translation: Maybe we won’t offer a rate cut. Employment growth may be shaky, but it’s too soon to tell — and income appears to be solid, according to Bernanke.

Bernanke didn’t offer any absolutes — and said the Fed would take all factors into consideration. Yet his growth concerns and the Fed’s increased acceptance that housing is still sinking and really is having a huge economic impact would indicate a cut is likely.

But he also said that "one must also take seriously the possibility that policy actions that have the effect of reducing stress in financial markets may also promote excessive risk-taking and thus increase the probability of future crises"– which would imply a rate cut isn’t likely.

Will the Fed cut the rate when they meet at the end of this month? Or will a cut come in the last two months of the year — or not at all? Post your thoughts below.