Fed Sees Need for Low Interest Rates Through Mid-2013

The skinny on the latest decision by the U.S. Federal Reserve -- the Fed clarified what the "extended period" for keeping short-term interest rates low means, as the central bank said it will keep interest rates low though mid-2013, with the target fed funds rate being 0 percent to 0.25 percent.

Further, U.S. Federal Reserve Chairman Ben Bernanke led seven voting board members supporting the decision, with the majority also saying it expects a slower-paced recovery than what the Fed had anticipated at its meeting in June.

Also, the Fed said it "will maintain its existing policy of reinvesting principal payments from its securities holdings. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."

On the U.S. economy, the Fed said:

"Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up. Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity."

On prices, the Fed said, "More recently, inflation has moderated as prices of energy and some commodities have declined from their earlier peaks. Longer-term inflation expectations have remained stable."

Markets Not Impressed By Decision

U.S. markets, at least intitially, didn't think the Fed's statement contained enough stimulus, or, at minimum, they didn't like the Fed's decision.

The Dow Jones Industrial Average, up about 138 points to 10,948 prior to the Fed announcement, reversed and plunged 275 points to trade 135 points lower in the initial 30 minutes after the decision. The dollar was also about one-half cent weaker versus the euro, at $1.4149 versus the euro and the 10-year U.S. Treasury note dipped six one-hundredths of a percentage point to 2.30 percent.

Fed Meets On Heels of S&P

The Fed's action occurred four days after Standard & Poor's stunned the financial and economic worlds with its controversial downgrade of the U.S. government debt.

In its decision, S&P cited the protracted, and at times, vitriolic partisan divide between the Democratic and Republican parties in Washington that, to some political analysts, reached a new low in the U.S. debt deal debate earlier this month.

What's more, the rhetoric often displayed more heat than light and didn't achieve enough, in S&P's view: the ratings agency wanted to see a larger budget deficit reduction than the roughly $2.4 trillion proposed, in two phases, by the U.S. debt deal act.

Many other economists and policy analysts wanted to see more substantial deficit reduction, as well, but that's not to say these officials agreed with S&P's downgrade conclusion -- far from it.

S&P's decision remains controversial. The two other major ratings agencies, Moody's and Fitch, haven't downgraded the U.S.

The Treasury Department also rejects S&P's analysis and conclusion, noting that S&P made a significant mathematical mistake in a document that it provided to the U.S. government.

"A judgment flawed by a $2 trillion error speaks for itself," a Treasury Department spokeswoman said, The New York Times reported Saturday.

Was the S&P downgrade premature? That's the view in certain investment and fiscal circles. True, the U.S. debt deal didn't lead to the $4 trillion federal spending reduction that many in financial circles had argued was necessary, but the conclusion that the U.S. -- one of the richest countries in the world, in terms of investment capital, with a remarkable scientific and technological edge in many sectors, and with an enormous productive capacity, and with a slumping economy that's still generating $14 trillion in GDP -- is somehow not capable of paying down its debt at an accelerated rate, can be philosophically challenged.

Monetary/Economic Analysis: Three members of the Fed dissented Tuesday, but the compelling action in that meeting is the specific language by the Fed that it expects to keep short-term interest rates low for another two years, through mid-2013.

That length and specificity suggests the Fed sees a very weak economy -- one that needs any tailwind that low rates for another two years can provide.

That said, the markets didn't get the third round of quantitative easing that some traders felt was necessary.

But as current Fed watchers -- and some former Fed members -- will no doubt point out, while the Fed didn't implement QE3 today.

Tomorrow is another day.