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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