Prime Rate

also known as the Fed, National or United States Prime Rate,
from the interest-rate specialists at www.FedPrimeRate.comSM

Thursday, November 15, 2007

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 11TH, 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 11TH, 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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