Could the Fed hold rates constant?

Greg Ip, as always, has some of the keenest insight. In tomorrow's Wall St. Journal, he has a piece called "Why Rate Cut Isn't a Sure Thing."

Both courses of action have risks. Perhaps the biggest is that the market's certainty that rates will be cut creates a burden on the Fed to deliver. Ordinarily, meeting market expectations isn't a goal in itself for the Fed.

But the current environment is more fragile than usual, and thus the consequences of disappointing the market are potentially more damaging. Against that, the Fed will have to weigh the risk that a cut will stoke inflationary psychology.

I've been going back and forth on this in my head for the last week. My head would like to see a bold move to keep rates constant at this meeting and re-evaluate in December. My gut thinks that Mr. Bernanke will err on the side of caution. That we're even having this discussion indicates that there is much work to be done on the communication channels between the Fed and the market.

The bottom line for me is still that the Fedspeak leading up to the quiet period before the meeting was pointing to more downside risks. I took that to mean that they are leaning toward easing.

So let's think about how a "no cut" scenario plays out. The only way they can stand pat is to give a statement that opens the door to future cuts should intermeeting data turn sour. Given that GDP and payroll data is just around the corner and a long time from that data to the next meeting, I think there is a risk that holding steady now could potentially cause expectations of future cuts to get built into the market really soon after this meeting. I don't think they would find that to be optimal. Furthermore, I doubt that they could get a unanimous vote to hold steady. Again, the expectations of future cuts are sure to be built in from day one.

But if they cut on Wednesday and made a statement that credibly states that they are done for a while, I think that would be easier for the market to digest, and probably lead to a better result in the long run. Then in the intermeeting period they could clarify that they really are done unless things turn sour--and speak frankly about what it would take. They would have to state that they think that they are (75 b.p. lower than this summer) now ahead of the curve, that they need to stay vigilant with regard to long term inflation expectations, and that they have revised their growth forecast upward.

Door number 2 seems the likely choice. But it's not a sure thing.

C'mon folks! What do you think?