Fed Keeps Rates Unchanged

The Federal Reserve kept short-term interest rates steady Tuesday at a meeting of the policy-setting Federal Open Market Committee.

The decision to leave rates alone came as no surprise to Fed watchers, who were almost unanimous in their view that the Fed would take no action because inflation is still not a problem despite rapid economic growth.

The FOMC left the federal funds rate at 4.75 percent and the discount rate at 4.5 percent. The two rates are charged to banks for overnight loans to meet reserve requirements and help determine other short-term rates in the economy.

"The Fed is pretty content," said Peter Kretzmer, senior economist at NationsBank Montgomery Securities. It was hard to find a Fed watcher who thought the FOMC would do anything.

"Why should they?" said Robert Brusca, economist at Nikko Securities.

"Everything's perfect," said Irwin Kellner, chief economist for CBS.MarketWatch.com and the Weller professor of economics at Hofstra University.

"They're still on the side of wait-and-see," said Sherry Cooper, chief economist at Nesbitt Burns.

A little over a month ago in semi-annual Humphrey-Hawkins testimony before Congress, Federal Reserve Chairman Alan Greenspan gave a textbook defense of the Fed's policy of holding firm, saying that risks to the economy were evenly balanced.

In recent public appearances, Greenspan and the other Fed officials have repeated the message that the economy is strong and inflation is low. Productivity gains have created an economy that can grow faster without fueling inflation, they've said.

Some monetarists believe the Fed should tighten rates to drain some of the extra liquidity out of the system that's inflated stock prices.

It's the old "irrational exuberance" theory revised. "The Fed really wants to be very careful here," Brusca said. "The market really pushed and pushed to get to 10,000, but what happens now?"

U.S. domestic demand is the only pillar of strength in the world economy, and that's based on two major factors: low interest rates and the wealth created by the bull market.

Higher rates could destroy or weaken both foundations of the U.S. economic expansion. The economy is expected to weaken a bit even without action by the Fed. "There are signs that we've topped out finally," Kretzmer said.

Even if the strength of the domestic economy argued for tighter rates, the fragile global economy would give the Fed reason to hesitate. Higher rates here would strengthen the dollar and weaken foreign economies.

"With all the fighting, with Russia, with weak foreign economies, the Fed really doesn't want to be a party pooper," Kellner said.

One new factor for the Fed to consider was the recent rise in oil prices, stemming from the agreement by the OPEC cartel to cut production. Higher oil prices, if they hold, will undoubtedly lead to higher inflation. With that possibility in mind, shoud the Fed do anything now?

"Commodity prices in general are well behaved," Brusca said. "It's only oil prices that are higher."

After the two-month surge in prices, oil is only back to where it was in October, when the Fed eased, Kellner points out.

"Oil prices don't mean nearly as much as they used to," Cooper said. "I don't think inflation is going to come back in any substantial way."

Written By Rex Nutting, Washington bureau chief for CBS MarketWatch