In case you have been living in a cave for the the last few months, the Federal Reserve has been aggressively lowering interest rates in the past few months and interest rates now sit at just 3%. Just 6 months ago interest rates were at 5.25%. So where should interest rates go from here? How much lower can the FOMC go with interest rates?
From a historical standpoint, 3.00% is quite low for interest rates. The Fed has clearly seen the economic data which shows the U.S. is likely headed for, or already in a recession. The housing market and the mortgage crisis has begun to drag down the entire economy. Consumer confidence and employment numbers are both discouraging of late, so I believe this quick movement has been completely justified.
As I have said in the past I believe employment data should be the number one thing that the FOMC watches in the near future. If employment data continues to swoon, the Fed will have no choice but to move again to lower interest rates further. The overall economy has no chance of holding up if the jobs market plunges and the unemployment rate surges.
So how low could the Fed go with interest rates? Most believe 2% is a level that is definitely doable and we will likely touch that number if a full-fledged recession hits the economy. The issue that complicates the whole fed funds rate talk much more is the fear of inflation.
Inflationary pressures have been quite low in the past few quarters, but Wednesday's CPI number bolstered the argument from strategists that say inflation will quickly become a major problem if the Fed keeps lowering interest rates at the rate they have been.
I personally the Fed must continue to fight the first order of business, which is righting the American economy and trying to stave off a severe recession. If it means taking interest rates much lower, then they should do just that. When the economy begins to rebound the Fed could then keep a closer eye on inflationary pressures and could raise rates quickly to try to catch up to those pressures. The bottom line here is that inflation is certainly a fairly large risk, but it is one that isn't imminent the way that a recession is. The FOMC should, and likely will, continue to lower rates if they feel it necessary to spur economic growth.
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