Federal Reserve Board’s most-recent rate cut implies that downturn has plateaued

The Federal Reserve Board did what was expected April 30 and
cut the funds rate another quarter point.

The markets pretty much knew what was coming, and what we
wanted to see were the changes in the statement. There were some, but the Fed
still left itself plenty of wiggle room to do what it pleased.

Maybe the biggest difference between the May 1 statement and
the one after the March 18 meeting was the removal of the phrase “downside
risks to growth remain.” That implies a lowering in the perception of risk that
the economy faces. Plus, instead of saying the “that the outlook for economic
activity has weakened further,” the committee opted to note that “economic
activity remains weak.” While that might seem like a small change, in the world
of Fed watching, it is not.

Essentially, the Fed seems to be implying that the downturn
has plateaued. That might not be the same as saying that growth is coming back,
but you have to hit bottom before you start to move forward again.

And then there is inflation. The Fed now believes the
uncertainty about the inflation outlook is high rather than rising. Again, that
might seem picky, but this is the FOMC statement we are talking about, and
every word is debated. To me, this elevates the concern about inflation.

Basically, my view of the statement is that the Fed eased
back on its stated concerns about the economy and slightly elevated its worries
about inflation. That should not surprise anyone. But by taking relatively
small steps, the FOMC may disappoint those who wanted the members to signal
that rate cuts were done. The committee couldn’t do that. It needs the
flexibility to act further if there are additional surprises or the economy
doesn’t come around as hoped. Given all the challenges the economy faces, that
only makes sense.

Going forward, I don’t expect any additional cuts unless
there is another crisis. The rebates will likely keep growth positive in the
second – and especially third – quarters. But when it comes down to it,
additional rate cuts would not likely accomplish much. The problem is not the
level of rates but the availability of funds. Until the credit crunch is eased
substantially, the fundamentals of the economy are not going to change
significantly. The Fed will likely be concentrating efforts of resolving the
illiquidity in the markets, and that is what should be done.

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Joel L. Naroff is chief economist with Commerce Bancorp of
Cherry Hill, N.J. The bank shares the Commerce brand with Swatara
Township-based Commerce Bank/Harrisburg. This column also appeared in our “View
From the Corner Office” blog at www.centralpennbusiness.com/blog.