Futures Market Now Certain That The Fed Will Cut Rates On December 11

According to the fed funds futures market, it's no longer a matter of if the Fed will cut, but by how much. The big question now is: will the Fed lower short-term rates by 25 basis points on December 11, or will it opt for an aggressive 50 basis point cut?

The fed funds futures market currently has odds on a rate cut at 100%, with 66% betting on a 25 basis point (0.25 percentage point) cut, and 34% betting that the Fed will cut short term rates by 50 basis points (0.50 percentage point.)

Influencing the futures market this week were more signs that the economy is slowing, and remarks made by high-ranking Fed officials about the still-worrisome state of U.S. credit markets. Here are some of the highlights:

• Credit market conditions are still quite bad. Fed boss Ben Bernanke made the following comments in a recent speech:
  
  

  ...Investors have focused on continued credit losses and write-downs across a number of financial institutions, prompted in many cases by credit-rating agencies’ downgrades of securities backed by residential mortgages. The fresh wave of investor concern has contributed in recent weeks to a decline in equity values, a widening of risk spreads for many credit products (not only those related to housing), and increased short-term funding pressures. These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors. Needless to say, the Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy...

• Home prices continue to decline, while inventories remain high. According to data compiled by the National Association of Realtors®, the median and average cost of a preowned (used) home declined from month to month since June of this year. Preliminary data indicate that last month, the median cost for a preowned home was $207,800, while the average cost was estimated at $255,500.
  
  Also, according to preliminary estimates released by the Commerce Department yesterday, the median cost of a brand-new home fell to $217,800; not since the fall of 2004 has the median price for a newly-built home been so low.
  
• Orders for durable goods (i.e. manufactured items that are built to last at least 3 years, like washing machines and jet aircraft) declined by 0.4% last month. Wall Street economists were expecting a gain of about 0.3%.
  
• The Consumer Confidence Index (CCI) fell to 87.3 this month. The CCI has declined each month since July of this year (July, 2007 CCI was 112.6.)
  
• For the week that ended on November 24, there were an estimated 352,000 new claims for unemployment benefits, which was 12,000 more claims than Wall Street economists were expecting.
  
• The Commerce Department reported that construction spending fell by 0.8% last month; Wall Street economists were expecting a decline of around 0.3%.

The Latest Odds

As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 100% (according to current pricing on contracts) that the FOMC will elect to lower the benchmark Federal Funds Target Rate by at least 25 basis points (0.25 percentage point) at the December 11^TH, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will be cut by at least 25 basis points at the December 11^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:

• Monday, December 3, 2007: The Institute for Supply Management releases the Purchasing Manager's Index (PMI) report for November.
  
• Friday, December 7, 2007: The Labor Department releases the November Employment Situation Report.

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Odds On A Rate Cut for the December 11 FOMC Meeting Now At 96%

You may have experienced some manifestation of the credit crunch going on in America's financial markets. Perhaps you were counting on getting a "no documentation" loan to buy your first house, but now find that these loans aren't available in your area. Or maybe the credit limit on your favorite credit card was recently reduced -- or perhaps the interest rate was raised -- even though you have an 800+ credit score and use credit very cautiously.

Hold on to your wallet, because credit markets may get worse before they get better. And to add salt to the proverbial wound, Wall Street has been increasing bets that a recession is lurking in the bushes, waiting for the perfect moment to pounce. Investors continued to move capital to the safety of government bonds today, which resulted in the yield on the benchmark 10-year treasury note dropping to 3.847%, a level not seen in over three years. The Dow Jones Industrial Average (DJIA) fell by 237.44 points, or 1.83%, while the S&P 500 lost 2.32% and the NASDAQ Composite fell by 2.14%. For the DJIA, today marked the first official correction since 2003. For the year, the DJIA is up only 2.249%.

The investors who trade in fed funds futures are now almost certain that the Fed will cut short-term rates again on December 11. If the Fed cuts, the dollar may get weaker against other major currencies; let's hope it doesn't collapse.


The Latest Odds

As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 96% (according to current pricing on contracts) that the FOMC will vote to lower the benchmark Federal Funds Target Rate by 25 basis points (0.25 percentage point) at the December 11^TH, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will be cut to 7.25% after the December 11^TH, 2007 FOMC monetary policy meeting: 96% (very likely)
  
• 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.

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Odds On A Rate Cut for the December 11 FOMC Meeting Now At 86%

Right now, the big question is: has the Fed cut short-term interest rates enough to preclude a recession, or will the Fed have to cut again on December 11 and risk serious reflation?

The Fed has been sending strong hints that it is done with lowering rates for now, but many on Wall Street are still quite confident that the Fed will once again cut the benchmark Fed Funds Target Rate next month.

Here's a clip from the statement released by the Fed when they cut rates on October 31:

"...The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth..."

And here's a clip from a recent speech made by Federal Reserve Governor Randall Kroszner:

"...A sequence of data releases consistent with the rough patch for economic activity that I expect in coming months would not, by themselves, suggest to me that the current stance of monetary policy is inappropriate...."

The fed funds futures market had odds on a rate cut at 92% last week. But odds are now at 86%, thanks in no small part to Dr. Kroszner's comments (as a Federal Reserve Governor, Kroszner is a voting member of the interest-rate setting Federal Open Market Committee [FOMC].)

With such hints from key Fed officials you would think that the odds on a rate cut would be much lower, right? But there are many on Wall Street who feel that important sectors of the economy and credit market conditions will deteriorate enough by December 11 that the Fed will opt to cut rates again.

Some of the most convincing data that supports the notion that the economy may be recession-bound comes from the U.S. Treasuries market. Historically and statistically, when the yields on Treasury securities with maturities from 3 months to 10 years are below the fed funds rate, a recession is likely to occur. Right now, the fed funds rate is 4.5%, which is an exact match with the Fed's target. Meanwhile, yields on government securities currently look like this:

• 3-Month Treasury Bill: 3.38%

• 6-Month Treasury Bill: 3.52%

• 2-Year Treasury Note: 3.20%

• 3-Year Treasury Note: 3.10%

• 5-Year Treasury Note: 3.57%

• 10-Year Treasury Note: 4.08%

Since all of the above yields are below 4.5%, it's no wonder that many on Wall Street are expecting trouble ahead.


The Latest Odds

As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 86% (according to current pricing on contracts) that the FOMC will vote to lower the benchmark Federal Funds Target Rate by 25 basis points (0.25 percentage point) at the December 11^TH, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will be cut to 7.25% after the December 11^TH, 2007 FOMC monetary policy meeting: 86% (likely)
  
• 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.

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Odds On A Rate Cut for the December 11 FOMC Meeting Now At 92%

Overall consumer prices rose by 0.3% last month, while the "core" index, which excludes food and energy, rose by 0.2%, according to data released by the Labor Department this morning. The monthly report on wholesale prices, released yesterday, showed that October wholesale inflation was tamer than economists were predicting, with the headline figure at +0.1%, and the core figure at +0.0%.

The latest core inflation numbers are reasonably healthy, which means that the Fed has some room to lower short-term interest rates again when the Federal Open Market Committee (FOMC) meets for the final monetary policy meeting of the year on December 11. The Fed may decide that another rate cut is necessary to help improve persistent liquidity issues in financial markets, the housing slump, and to forestall a recession.

According to the fed funds futures market, rates are likely to be slashed by another 0.25 percentage point next month, as investors are currently 92% certain (according to current pricing on contracts) that the Fed will vote to ease.

Another interest rate cut next month might cause the already weak dollar to continue to decline against other major currencies, like the euro and the Loonie. The Fed really doesn't mind, as a weak dollar makes American goods and services more attractive to non-U.S. businesses and consumers, and it makes foreign goods more pricey for Americans -- both are good for the U.S. economy. It also makes foreign travel more expensive for Americans, which might be enough to convert that European vacation to a holiday in Florida.

Another rate cut would also stoke the flames of inflation, and Americans are already getting grumpy about the high cost of fuel, as well as escalating prices at the supermarket. Consumers are getting tired of hearing the Fed talk about core inflation, when it's headline inflation that really matters to their bottom line. Not all of us drive or buy heating oil, but we all eat.

The good news is that the Fed has been listening, as evidenced by comments made by Fed chief Bernanke in a recent speech. Here's a clip:

"...Ultimately, households and businesses care about the overall, or 'headline,' rate of inflation; therefore, the FOMC should refer to an overall inflation rate when evaluating whether the Committee has met its mandated objectives over the long run. For that reason, the Committee has decided to publish projections for overall inflation as well as core inflation. In its policy statements and elsewhere, the Committee makes frequent reference to core inflation because, in light of the volatility of food and energy prices, core inflation can be a useful short-run indicator of the underlying trend in inflation. However, at longer horizons, where monetary policy has the greatest control over inflation, the overall inflation rate is the appropriate gauge of whether inflation is at a rate consistent with the dual mandate..."

The FOMC also announced that it will release projections for economic growth and inflation not twice but four times every year from now on.

The Latest Odds

As of right now, the investors who trade in fed funds futures have odds at 92% (according to current pricing on contracts) that the FOMC will vote to cut the benchmark Federal Funds Target Rate by 25 basis points (0.25 percentage point) at the December 11^TH, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will be cut to 7.25% after the December 11^TH, 2007 FOMC monetary policy meeting: 92% (likely)
  
• 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.

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Odds On A Rate Cut for the December 11 FOMC Meeting Now At 70%

Some good news and bad news related to the U.S. economy to report today. First, the bad:

• Problems related to America's low-quality mortgage loans and financial market liquidity crunch continue to plague the nation. The Dow Jones Industrial Average (DJIA) fell by over 360 points yesterday (all 30 DJIA components declined on the day), as investors got bearish on financial and other stocks that may be affected by subprime debt. Auto giant General Motors lost $39 billion last quarter, the biggest quarterly loss ever for the company, and, believe it or not, subprime debt was a factor (GM owns about half of the financing company GMAC, which has exposure to the subprime nightmare.)
  
• The dollar's decline has many economists, academics and investors wondering if countries that hold huge stacks of the currency-- like China and Japan -- will eventually give up on it and rearrange their foreign-asset portfolios. Debt has been propping up the American economy for some time now, and if U.S. Treasuries suddenly become unpalatable, the American consumer ultimately will suffer (this scenario is not likely, however, since dumping dollars would result in a substantial capital loss, and both China and Japan want Americans to keep spending beyond their means on the stuff they make.)
  
• Right now, a barrel of crude oil for future delivery costs $96.90, and is widely expected to rise above the $100 level in the near future. The dollar's decline, in cahoots with strong demand and inadequate refining capacity, are all driving prices higher. It's likely that Americans will eventually curtail their spending as a result, which could precipitate a recession.

Good news:

• Preliminary figures from the Labor Department indicate that non-farm productivity advanced by 4.9% last quarter, while labor costs declined by 0.2%. This bodes well for the American economy and the American consumer: increased productivity and lower labor costs mean an owner can do more hiring or pay his/her current workers more without passing the cost onto the consumer (which would contribute to inflation.) All in all, it's good news for Americans' standard of living.

It looks like the bad news easily outweighs the good, doesn't it? Well, traders in fed funds futures certainly think so, as they are betting that the Fed will once again lower short-term interest rates when the Federal Open Market Committee (FOMC) meets for the final monetary policy meeting of the year on December 11.


The Latest Odds

As of right now, the investors who trade in fed funds futures have odds at 70% (according to current pricing on contracts) that the FOMC will vote to cut the benchmark Federal Funds Target Rate by 25 basis points (0.25 percentage point) at the December 11^TH, 2007 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will be cut to 7.25% after the December 11^TH, 2007 FOMC monetary policy meeting: 70% (somewhat likely)
  
• 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.

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