Prime Rate

also known as the Fed, National or United States Prime Rate,
from the interest-rate specialists at www.FedPrimeRate.comSM

Thursday, November 16, 2006

Probability of A Rate Cut for March 21, 2007 Drops to 6%

Between mid-2004 and mid-2006, Greenspan, Bernanke, and their Fed colleagues pushed the benchmark Fed Funds Rate from 1% to the current 5.25% in quarter-point increments, which has produced the desired effect of taming inflation without pushing the economy into recession (so far.) Investors and central bankers should be pleased with the latest inflation data: the October Producer Price Index (PPI) report suggests that wholesale prices eased at a pace that beat economists' expectations, and the October Consumer Price Index (CPI) report indicates that core consumer prices rose at a Fed-friendly 0.1% last month.

The latest inflation figures should be enough to quiet at least some of the murmuring related to price stability that's been going on at the Fed. Fed officials have expressed serious concern about inflation as recently as the last Federal Open Market Committee (FOMC) meeting, the minutes of which were released yesterday. Here's a clip:

"...All meeting participants expressed concern about the outlook for inflation. Most participants expected core inflation to edge lower, in part as the effects of the run-up in energy prices in recent years waned. And shelter costs were not expected to add materially to inflation going forward. Moreover, moderate growth in aggregate demand and the associated modest easing of pressures on resource utilization should also contribute slightly to the slowing in core inflation. Recent changes in core prices had declined slightly from earlier in the year. Nonetheless, nearly all participants viewed the current rates of core inflation as uncomfortably high and stressed the importance of further moderation. 
The available measures suggested that medium- and long-term inflation expectations remained around the levels seen for the past several years, although in the view of some participants these expectations were probably higher than would be consistent with their assessment of long-run price stability. Participants were concerned that inflation expectations could begin to drift upwards if core inflation remained elevated for a protracted period. Any such rise in inflation expectations and associated upward pressure on inflation itself would likely prove costly to reverse. Although some participants noted that the recent slowing in core inflation had helped to allay their fears of a further sustained increase in inflation, all participants emphasized that the risks around the desired downward path to inflation remained to the upside.
All meeting participants expressed concern about the outlook for inflation. Most participants expected core inflation to edge lower, in part as the effects of the run-up in energy prices in recent years waned. And shelter costs were not expected to add materially to inflation going forward. Moreover, moderate growth in aggregate demand and the associated modest easing of pressures on resource utilization should also contribute slightly to the slowing in core inflation.
Recent changes in core prices had declined slightly from earlier in the year. Nonetheless, nearly all participants viewed the current rates of core inflation as uncomfortably high and stressed the importance of further moderation. The available measures suggested that medium- and long-term inflation expectations remained around the levels seen for the past several years, although in the view of some participants these expectations were probably higher than would be consistent with their assessment of long-run price stability.
Participants were concerned that inflation expectations could begin to drift upwards if core inflation remained elevated for a protracted period. Any such rise in inflation expectations and associated upward pressure on inflation itself would likely prove costly to reverse. Although some participants noted that the recent slowing in core inflation had helped to allay their fears of a further sustained increase in inflation, all participants emphasized that the risks around the desired downward path to inflation remained to the upside..."

Have We Hit Neutral?


Short-term interest rates may be at just the right level, or as the economists and central bankers like to put it, the "neutral rate" -- a Fed Funds Target Rate that neither stimulates nor inhibits U.S. economic growth. Many Federal Reserve officials believe that we are at or close to neutral with the current Fed Funds Target Rate of 5.25%. On November 2, 2006, Federal Reserve Board Governor Susan Bies commented:

"...At 5.25, many of us think we're in that range..."

8.25% Will Be With Us for A While

The U.S. prime interest rate is very likely to remain at the current 8.25% right through the coming winter. The economy continues to send mixed signals: the job market is tight right now, and today's Philadelphia Fed Survey indicates that Philadelphia-area manufacturing is the strongest it's been in 3 months. Furthermore, today's report on Industrial Production showed an increase of 0.2% last month, which is exactly what economists were expecting.

On the flip side, many economists are predicting that the all-important housing market will continue to deflate for some time. More evidence of sluggishness in the U.S. economy was released two days ago by Commerce Department, in the form of the October Retail Sales report.

Bottom line: in this type of mixed economic environment, the Fed is likely to hold on interest rates for at least two more FOMC monetary policy meetings.


The Latest Odds

As expected, interest-rate speculators have reacted to recent inflation and manufacturing data. As of right now, the investors who trade in Fed Funds Futures have odds at around 6% (according to current pricing on contracts) that the Federal Open Market Committee (FOMC) will vote to lower the benchmark Fed Funds Target Rate by 25 basis points at the March 21ST, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Predictions:
  • In all likelihood, the Prime Rate will remain at the current 8.25% after the December 12TH and January 31ST FOMC monetary policy meetings.
  • Current odds that the Prime Rate will be cut to
    8.00% on March 21ST, 2007: 6% (very unlikely)

  • NB: Prime Rate = (The Fed Funds Target Rate + 3)

The odds related to Fed 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 to this weblog for the latest odds. Odds may experience a significant shift on the release of the following economic reports:

  • Tuesday, November 28, 2006: The National Association of Realtors releases the Existing Home Sales report for October.
  • Wednesday, November 29, 2006: The Commerce Department releases both the preliminary Gross Domestic Product (GDP) report for Q3, 2006, and the New Home Sales report for October.
  • Friday, December 8, 2006: The Labor Department releases the Employment Situation report for November.

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