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Why the Fed Didn’t Raise Rates

Fed Leaves Interest Rates Unchanged, Citing Continuing Economic Rebound 1:05

Stocks fell sharply Friday as investors processed the lingering cloud of uncertainty after the Fed's decision to not raise rates from their record low.

Major markets fell 1 percent after the open, with the Dow losing more than 250 points.

The tumbles might appear to be a referendum by investors on the Fed's inaction, but there's actually longer-term forces at work. So just why did the Federal Reserve decide to leave rates untouched?

At a news conference, Yellen declined to spell out what exactly would give the Fed enough confidence to raise the federal funds rate - the interest that banks charge each other - from near-zero.

"I can't give you a recipe for exactly what we're looking to see," she said.

What she does see now are too many lingering risks.

Parts of the economy are ailing despite the drop in unemployment. Pay growth has barely improved, for example. And millions hold jobs below their education levels or can't find full-time work. The global slowdown emanating from Europe and China has recently thrown financial markets into turmoil, a risk specifically raised by the Fed in its statement Thursday.

In addition, the Fed's preferred inflation measure is tracking just 0.3 percent annually, largely because of falling energy prices. The Fed has a mandate to stabilize price levels, which it has defined as 2 percent annual inflation. Too-low inflation tends to cause many people to postpone purchases, hurting consumer spending and economic growth. Ultra-low inflation also makes the inflation-adjusted cost of a loan more expensive.

But a rate raise would make many things more expensive for consumers, from monthly credit card bills on carried debt to higher mortgage rates for some. It would also mean savers would start earning a bit more in interest on their bank accounts for the first time in years.

Though the Fed had not been expected to raise interest rates for the first time in more than nine years, the initial downward moves in the market Friday show investors appeared worried by the lack of guidance from the central bank and its concern about the global economy.

In its accompanying policy statement, the Fed revealed worries that "recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near-term".

Though Fed Chair Janet Yellen said a rate hike this year is possible, much depends on incoming economic data. In its statement, the Fed cited needing to see a stronger labor market and inflation moving towards that. 2 percent. Not knowing when that may come only adds to the uncertainty for investors.

"When is the Fed going to move rates?" former New York Fed executive vice president Dino Kos asked on CNBC Friday.

"The sort of stock answer is the same answer we've had for the last five years: six months from now."