The next two weeks are the traditional holiday “dead time” in the markets (bond-market people use such cheery metaphors all year ’round), and so the passage of an extraordinary transition this week has been lost on vacation.

Like your luggage, to be found in January.

The Fed’s statement after its last 12 consecutive meetings said that it had acted to “remove excess accommodation.” After the 13th, on Tuesday, raising its rate again to 4.25 percent, the Fed removed the phrase itself. Long-term mortgage rates promptly fell.

The Fed has been on automatic pilot for 18 months, one drip-drip quarter-point at a time, each hike as surprising to the markets as that day’s sunrise. The automation made sense: at a 1 percent overnight cost of money, the Fed had successfully intercepted the risk of deflation 2002-2004, and everyone understood that the Fed could no longer allow that free-money lending.

The only question was where the Fed would stop. Not even the Fed knew that, nor does it know now — too many other things are moving. Surprises like the inflation risk from $60 oil, and the refusal of long-term rates to rise along with the Fed, thereby limiting the impact of the Fed’s hikes.

However, there are some measures for the overnight cost of money that are independent of other accidents. The most important is the spread between the Fed funds rate and inflation; a spread of 2 percent to 2.5 percent by historical rule is a neutral Fed policy, neither leaning against the economy nor goosing it. The core rate of inflation is only 2.1 percent, so a 4.25 percent Fed funds rate is now in the neutral range.

By other measures the Fed is still on the easy side: Fed-funds-to-GDP ought to have the funds rate a couple of points above GDP, and they are now about equal, as are funds-to-nominal-CPI. However, even though fixed mortgage rates are below the highs in ’03 and ’04, the Fed has removed adjustable-rate mortgages as a propellant for housing. A 7.25 percent “prime” rate today is not an accommodative number.

The Fed’s inflation worries have been salved by the globalized labor market. All prior energy-price cost-pushed inflation episodes have quickly spread to wage inflation, but not this time, as the ready substitution of Asian labor for American makes it difficult for American wages to inflate in any way. The Fed’s statement gave a nod to the possible inflationary consequences from “increases in resource utilization” — meaning unemployment falling too low — but the Fed has things to worry about besides inflation.

Other Worry Number One: overdoing the medicine. The Fed is looking back at a huge cumulative rate hike, and knows that its effects will not be fully evident in the economy for a year. Only in moments of inflation going out of control is the Fed single-minded, recession be damned, as in 1973-74 and 1979-1981; this is not a comparable situation.

There is no sharp dividing line between easy monetary policy and tight — the economy is too ambiguous and changeable for that. The definitive line in Tuesday’s statement says “some further measured policy firming is likely to be needed,” which means a stopping point anywhere from 4.5 percent on Feb. 1 to something a little over 5 percent by summer 2006. The long-term rate improvement this week reflects the sure knowledge in the bond market that any increase from here is likely to be reversed before the end of 2006, and a hunch that the Fed has already tightened too far into an economy likely to slow of its own accord.

Expect some rate volatility as those two bond-market assumptions are alternately confirmed and challenged by new data in the next couple of months. By spring, I think they will be confirmed without challenge.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at


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