Despite Positive Economic News, Futures Market Still Betting On A Rate Cut for September 18

A week ago, the fed funds futures market was certain that the Federal Open Market Committee (FOMC) will vote to lower short-term interest rates at their next monetary policy meeting on September 18. Well, as of today, the futures market is still certain that the Fed will cut rates next month, despite some positive economic news released by the government on Friday, and some interesting moves made by some of America's biggest banks. In fact, a significant minority in the market are betting that the Fed will lower rates by 50 basis points, which would in turn knock the Prime rate down to 7.75%.

Notable news from this week:

• Bank of America purchased a $2 billion stake in Countrywide Financial in an effort to stabilize the mortgage giant. Countrywide in the nation's #1 home-loan lender.
  
• The Bank of America, Citigroup, JP Morgan Chase and Wachovia each borrowed $500 million via the Federal Reserve's discount window at 5.75%. These large banks didn't need to borrow the cash at the discount rate (they could have borrowed and paid less than 5% for the privilege via the fed funds market.) These were basically "follow our lead" actions, to get other banks to borrow via the discount window and ultimately get more cash moving around the financial markets.
  
• On Friday, the Commerce Department reported that orders for durable goods -- goods that are designed to last more than 3 years, like washing machines -- rose by 5.9% last month. Economists were expecting a rise of about 1.0% for July.
  
• Last month, 870,000 newly-built homes were sold across the country, according to the Commerce Department. That was 2.8% above the revised June figure. Economists were expecting around 820,000 new home sales for July.

Stay tuned for the big one: The Employment Situation report for August, which will be released the morning of September 7^TH. The forecast for the Prime Rate will be far more meaningful after the release of the August jobs report.


The Latest Odds

As of right now, the investors who trade in fed funds futures have odds at 100% (according to current pricing on contracts) that the FOMC of the Federal Reserve will vote to lower the benchmark Federal Funds Target Rate by at least 25 basis points at the September 18^TH, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will be cut to 8.00% after the September 18^TH, 2007 FOMC monetary policy meeting: 100% (certain)
  
• 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. Odds may experience a significant shift on the release of the following economic report:

• Friday, September 7, 2007: The Labor Department releases the Employment Situation report for August.

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Fed Cuts Discount Rate; Future Market Now Certain That The FOMC Will Cut The Fed Funds Target Rate On September 18

Earlier today, in a continuing effort to calm the rough waters of the financial markets, the Fed cut the Discount Rate from 6.25% to 5.75%. And to get financial institutions to use the discount window, Fed officials assured major U.S. banks that using the discount window would not be perceived as a sign of weakness (the Fed's discount window is usually only tapped by banks when they can't secure temporary funds from other banks.)

The Federal Open Market Committee (FOMC) of the Federal Reserve also issued the following statement today:

"Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

Voting in favor of the policy announcement were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Richard W. Fisher; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Michael H. Moskow; Eric Rosengren; and Kevin M. Warsh."

The above statement is significant because:

• The group dropped any language related to inflation, which is appropriate considering current conditions. The Fed's priorities have shifted. This means that the Fed is prepared to lower the Fed Funds Target Rate if the current credit crisis doesn't abate in a significant way before the next FOMC monetary policy meeting.
  
• Also very significant:
  

  "...the Federal Open Market Committee judges that the downside risks to growth have increased appreciably..."

  To translate the Fed speak, "increased appreciably" can be interpreted to mean "a whole lot." Yet another signal that the Fed's is ready to lower the Fed Funds Target Rate if the cautious steps it has taken so far don't work.

Five days ago, I was not of the opinion that the Fed would cut the Fed Funds Target rate next month. However, having read today's FOMC statement, I am now in agreement with the Fed Funds Futures market, which is now pricing in 100% odds that the Fed will lower rates on September 18.

Wall Street was happy with today's Fed actions: the Dow Jones Industrial Average ended the day with a gain of over 233 points.

The Latest Odds

As of right now, the investors who trade in Fed Funds Futures have odds at 100% (according to current pricing on contracts) that the Federal Open Market Committee (FOMC) of the Federal Reserve will elect to lower the benchmark Federal Funds Target Rate by 25 basis points at the September 18^TH, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will be cut to 8.00% after the September 18^TH, 2007 FOMC monetary policy meeting: 100% (certain)
  
• NB: 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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Futures Market Is Very Confident That The Fed Will Cut Rates On September 18, 2007

Problems with America's subprime mortgages continue to create waves of fear in markets all around the world. Central banks across the globe have been pumping money into the world's banking systems in an effort to cool the sweaty brows of investors and bankers, and restore confidence and stability to credit markets. Last Friday, the Fed executed temporary repurchase agreements which ended up pumping a total of $38 billion into the nation's financial system, the most since the terrorist attacks of September 11, 2001. The European Central Bank (ECB) pumped $65.2 billion into the eurozone economy. More recently, Japan's central bank injected $5 billion into Japanese financial markets.

But, of course, the big question is: will the current credit crunch prompt the Fed to cut short-term interest rates at the next Federal Open Market Committee (FOMC) meeting, scheduled to take place on September 18, 2007? According to the Fed Funds Futures market: yes, the Fed will vote to lower rates (98% probability.)

Usually, I'm with the futures market, especially when it comes to predictions that are within 45 days of the next FOMC meeting, where predictions based on the Fed Futures market are most accurate. But I'm not with the futures market today. Yes, there's some liquidity-related ugliness out there right now, but that's not enough to get Bernanke & Co. to cut rates. The Fed is clearly interested in defending the currency, as evidenced by the Fed's incessant murmuring about the potential for the pace of inflation to rise to an unacceptable level. Here's a snippet from last week's Fed meeting:

"Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected."

Predictions are going to be all over the place right now. It's an interesting time and the Fed has made some interesting moves. For example, instead of temporarily buying back treasury notes and bills -- as the Fed did after the terrorist attacks on the World Trade Center -- the Fed chose instead to repurchase mortgage-backed securities (MBS) on August 9. This will almost certainly have the effect of shoring up the nation's flagging housing sector for a spell.

So, my prediction: the Fed will meet on September 18 and will vote to maintain short-term rates, including the Prime Rate, at their current level. As for predictions based on the Fed Funds Futures market:

The Latest Odds

As of right now, the investors who trade in Fed Funds Futures have odds at 98% (according to current pricing on contracts) that the Federal Open Market Committee (FOMC) of the Federal Reserve will elect to lower the benchmark Federal Funds Target Rate by 25 basis points at the September 18^TH, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will be cut to 8.00% after the September 18^TH, 2007 FOMC monetary policy meeting: 98% (very likely)
  
• NB: 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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Fifth FOMC Meeting of 2007 Adjourned: The U.S. Prime Rate Stays at 8.25%

The Federal Open Market Committee (FOMC) of the Federal Reserve has just adjourned its fifth monetary policy meeting of 2007, and, in keeping with the latest forecast, the FOMC has voted to leave short-term interest rates at their current level. Therefore, the benchmark Federal Funds Target Rate will remain at 5.25%, and the Wall Street Journal® Prime Rate (also known as the U.S. or Fed Prime Rate) will remain at the current 8.25%.

Here's a clip from the press release that was issued by the FOMC earlier this afternoon:

"...The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Michael H. Moskow; William Poole; Eric Rosengren; and Kevin M. Warsh..."

The next FOMC monetary policy meeting will occur on September 18, 2007.

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