Odds On Another Prime Rate Increase at the End of June Jump to 72% In Response to Minutes from the May 10 Monetary Policy Meeting

Earlier today, the Federal Open Market Committee (FOMC) of the Federal Reserve released the minutes from their May 10, 2006 monetary policy meeting. Here's a snippet from today's Fed press release:

"...Although the Committee discussed policy approaches ranging from leaving the stance of policy unchanged at this meeting to increasing the federal funds rate 50 basis points, all members believed that an additional 25 basis point firming of policy was appropriate today to keep inflation from rising and promote sustainable economic expansion. Recent price developments argued for another firming step at today's meeting. Core inflation recently had been a bit higher than had been expected, and several members remarked that core inflation was now around the upper end of what they viewed as an acceptable range. Moreover, a number of factors were augmenting the upside risks to inflation: the surge in energy and commodity prices, some recent weakness in the foreign exchange value of the dollar, and the possibility that the apparent increase in inflation expectations could, if it persisted, impart momentum to inflation. In addition, the economy appeared to be operating at a relatively high level of resource utilization and had been growing quite strongly, and whether economic growth would moderate to a sustainable pace was not yet clear. At the same time, members also saw downside risks to economic activity. For example, the cumulative effect of past monetary policy actions and the recent rise in longer-term interest rates on housing activity and prices could turn out to be larger than expected. Still, it seemed most likely that, with modest further policy action, including a 25 basis point firming today, growth in activity would moderate gradually over coming quarters, pressures on resources would remain limited, and core inflation would stay close to levels experienced over the past year.

Given the risks to growth and inflation, Committee members were uncertain about how much, if any, further tightening would be needed after today's action. In view of the risk that the outlook for inflation could worsen, the Committee decided to repeat the indication in the policy statement released after the March meeting that some further policy firming could be required. However, the Committee agreed to emphasize that 'the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information.' Members debated the appropriate characterization of inflation expectations in the statement. Low and stable inflation expectations were key to the attainment of the Committee's dual objectives of price stability and maximum sustainable economic growth. However, the apparent pickup in longer-term expectations, while worrisome, was relatively small. They remained within the range seen over the past couple of years, and the increase could well reverse before long. Accordingly, it appeared appropriate to characterize inflation expectations again as 'contained'..."

The Latest Odds On A Prime Rate Increase on June 29

The odds related to the FOMC raising the benchmark Fed Funds Target Rate on June 29 have changed in response to today's Fed minutes. Right now, Federal Funds Futures traders have odds at around 72% (according to current pricing) that the Fed will vote to raise the Fed Funds Target Rate from the current 5.00%, to 5.25%. Prior to this afternoon's release of the May 10 monetary policy meeting minutes, odds on another 25 basis point increase were at 58%.

If the FOMC votes to raise the Fed Funds Target Rate to 5.25% on June 29, then the U.S. Prime Rate (Wall Street Journal® Prime Rate) will jump from the current 8.00%, to 8.25%.


The odds related to the Fed Funds Futures trade--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 (Odds may experience a significant shift when the U.S. Department of Labor's Bureau of Labor Statistics releases their Employment Situation report on Friday, June 2, 2006.)

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