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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