The Federal Reserve cut the funds rate on Tuesday by .25 of a percent. The stock market reacted negatively to this as many expected an even greater cut. There was no improvement in mortgage rates; in fact mortgage rates increased as the market had anticipated a more aggressive rate cut.

Typically, consumers believe that widely publicized rate cuts by the Fed will cause an immediate improvement in rates. This is often not the case. In many cases the market anticipates the Fed's adjustments and the market has already priced in the adjustment by the time of the announcement. Only in the case where there is a difference between the expected outcome and the real outcome - such as this case - are market rates affected. In this case the market expected rates to be cut by half a percentage point, not a quarter. And thus market rates increased after the Fed announcement.

Inflation concerns were the other big factor that caused rates to increase this week. On the day after the rate cut, the Fed announced a plan to auction off more bonds, injecting more cash into the system. However, the new additional supply of bonds has called their prices to fall, increasing yields -- and rates.

Additionally, Thursday and Friday brought us much higher than expected Producer Price Index and Consumer Price Index readings: two key measures of inflation. Retail Sales data posted Thursday also showed much higher than expected readings, giving the market a clear signal. Spending is strong, inflation remains a significant risk.

The inflationary pressures reported late in the week, affirm in retrospect that the Fed's decision to reduce rates only by .25 of a point, rather than by half of a point may have been a wise one. Lowering interest rates to help support the struggling housing sector must be done in balance with the rest of the economy, specifically, existing inflationary pressures.

Published on December 14, 2007