Prime Rate

also known as the Fed, National or United States Prime Rate,
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Friday, August 17, 2007

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 18TH, 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 18TH, 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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