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Prime Rate

also known as the Fed, National, U.S. and WSJ Prime Rate

Monday, November 19, 2007

Odds On A Rate Cut for the December 11 FOMC Meeting Now At 86%

Right now, the big question is: has the Fed cut short-term interest rates enough to preclude a recession, or will the Fed have to cut again on December 11 and risk serious reflation?

The Fed has been sending strong hints that it is done with lowering rates for now, but many on Wall Street are still quite confident that the Fed will once again cut the benchmark Fed Funds Target Rate next month.

Here's a clip from the statement released by the Fed when they cut rates on October 31:

"...The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth..."

And here's a clip from a recent speech made by Federal Reserve Governor Randall Kroszner:

"...A sequence of data releases consistent with the rough patch for economic activity that I expect in coming months would not, by themselves, suggest to me that the current stance of monetary policy is inappropriate...."

The fed funds futures market had odds on a rate cut at 92% last week. But odds are now at 86%, thanks in no small part to Dr. Kroszner's comments (as a Federal Reserve Governor, Kroszner is a voting member of the interest-rate setting Federal Open Market Committee [FOMC].)

With such hints from key Fed officials you would think that the odds on a rate cut would be much lower, right? But there are many on Wall Street who feel that important sectors of the economy and credit market conditions will deteriorate enough by December 11 that the Fed will opt to cut rates again.

Some of the most convincing data that supports the notion that the economy may be recession-bound comes from the U.S. Treasuries market. Historically and statistically, when the yields on Treasury securities with maturities from 3 months to 10 years are below the fed funds rate, a recession is likely to occur. Right now, the fed funds rate is 4.5%, which is an exact match with the Fed's target. Meanwhile, yields on government securities currently look like this:

  • 3-Month Treasury Bill: 3.38%
  • 6-Month Treasury Bill: 3.52%
  • 2-Year Treasury Note: 3.20%
  • 3-Year Treasury Note: 3.10%
  • 5-Year Treasury Note: 3.57%
  • 10-Year Treasury Note: 4.08%

Since all of the above yields are below 4.5%, it's no wonder that many on Wall Street are expecting trouble ahead.


The Latest Odds

As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 86% (according to current pricing on contracts) that the FOMC will vote to lower the benchmark Federal Funds Target Rate by 25 basis points (0.25 percentage point) at the December 11TH, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

  • Current odds that the Prime Rate will be cut to 7.25% after the December 11TH, 2007 FOMC monetary policy meeting: 86% (likely)

  • NB: U.S. Prime Rate = (The Federal Funds Target Rate + 3)

The odds related to federal-funds futures contracts -- widely accepted as the best predictor of where the FOMC will take the benchmark Fed Funds Target Rate -- are continually changing, so stay tuned for the latest odds.

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