Short Term Interest Rates

Fed Funds Target Rate: 3.00%

The Fed is on track to have the Fed Funds rate at 4.00 - 4.25% by year end 2005. A growing number of observers now think the Fed may quit raising rates at either 3.25% or 3.50%, citing evidence of an economic slowdown.

The Fed undertakes to raise rates when: 1) economic growth is strong, 2) capacity utilization is on the rise, 3) inflation pressures are intensifying and 4) short term business credit demand is advancing at a faster clip than is monetary liquidity.

For now, only condition (1) is clearly suspect. Capacity utilization is still in an uptrend, credit demand is very strong (up 11% yr/yr) and inflation indicators have not settled down enough to warrant a clear call that the latest push up on inflation has ended.

Since the speculation about a an interim top in rates will continue, below are some benchmarks that might prove helpful in benchmarking the action:

A. The Fed would take notice if the ISM index for manufacturing purchase management was to dip below 50%. It is now in a downtrend, with the April reading at a moderately strong 53.3%.

B. The capacity utilization rate, which is trending up, begins to flatten out. Important here besides the growth of production is the growth of capacity itself, which is advancing at a very slow 1.2%.

C. The CRB Futures Index, now at 300.5, dips further and confirms a solid seasonal topping pattern. The CPI registers a couple of months of 0.2% or lower readings.

If it looks like the economy is clearly slowing and inflation pressures are abating, the Fed would likely wave off the sharp rise in credit demand, believing that it reflected financing of inventory accumulation with the latter being seen as unsustainable.