Futures Market Certain of 50 Basis Point Cut Despite Rising Prices

Two days ago, the Labor Department reported that wholesale prices rose by a very ugly 1.0% during January 2008. Consumer prices rose by 0.4% during the same month. Crude oil for future delivery is currently trading at $102.24 per barrel (no, that's not a typo), while New York Spot Gold finished the day at $969.50 per ounce. With inflation stealing current economic news headlines, how is it that the fed funds futures market is once again 100% certain that the Fed will cut short-term rates by at least 50 basis points (0.50 percentage point) by March 18?

Here's what Fed boss Ben Bernanke had to say about it in testimony before Congress yesterday:

"...The economic situation has become distinctly less favorable since the time of our July report. Strains in financial markets, which first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for many households and businesses. The growth of real gross domestic product (GDP) held up well through the third quarter despite the financial turmoil, but it has since slowed sharply. Labor market conditions have similarly softened, as job creation has slowed and the unemployment rate--at 4.9 percent in January--has moved up somewhat.

Many of the challenges now facing our economy stem from the continuing contraction of the U.S. housing market. In 2006, after a multiyear boom in residential construction and house prices, the housing market reversed course. Housing starts and sales of new homes are now less than half of their respective peaks, and house prices have flattened or declined in most areas. Changes in the availability of mortgage credit amplified the swings in the housing market. During the housing sector's expansion phase, increasingly lax lending standards, particularly in the subprime market, raised the effective demand for housing, pushing up prices and stimulating construction activity. As the housing market began to turn down, however, the slump in subprime mortgage originations, together with a more general tightening of credit conditions, has served to increase the severity of the downturn. Weaker house prices in turn have contributed to the deterioration in the performance of mortgage-related securities and reduced the availability of mortgage credit.

The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and closely related industries...

...The rate of inflation that is actually realized will of course depend on a variety of factors. Inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities or if rates of domestic resource utilization fall more than we currently expect. Upside risks to the inflation projection are also present, however, including the possibilities that energy and food prices do not flatten out or that the pass-through to core prices from higher commodity prices and from the weaker dollar may be greater than we anticipate. Indeed, the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month. Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored. Any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and could reduce the flexibility of the FOMC to counter shortfalls in growth in the future. Accordingly, in the months ahead, the Federal Reserve will continue to monitor closely inflation and inflation expectations..."

Other economic news supporting predictions that the Fed will cut aggressively next month:

• Housing: On Monday, the National Association of Realtors® reported that sales of previously occupied homes fell by 0.4% last month. Between 01/2007 and 01/2008, sales of used homes were down 23.4%. And according to preliminary estimates, the median cost of a used home fell to $201,100, while the average price sank to $247,700.
  
• Housing: On Wednesday, the Commerce Department reported that sales of newly built (virgin) homes fell by 2.8% last month. Between 01/2007 and 01/2008, sales of new homes were down 33.9%. According to preliminary estimates, the median price of a brand new home declined to $216,000.
  
• Consumer Spending: On Tuesday, The Conference Board reported that the Consumer Confidence Index (CCI) fell to 75.0 for this month (February.) Wall Street economists were expecting the figure to come in at around 81.3. The CCI has been declining since the summer of 2007 (the 07/07 figure was 111.9.) For the CCI, the baseline score of 100 is associated with 1985 survey results.
  
• Manufacturing: Yesterday, the Commerce Department reported the orders for durable goods fell by 5.3% last month. Wall Street was expecting a decline of about 3.5%. Durable goods = items built to last 3 years or more, like airplanes, cars and cooking ranges.

As of right now, the fed funds futures market has odds at 62% that the Fed will cut the benchmark Fed Funds Target Rate by 50 basis points (0.50 percentage point) at or before the March 18^TH Federal Open Market Committee (FOMC) monetary policy meeting. A 38% minority in the futures market are betting that the Fed will cut short-term rates by 75 basis points at some point between now and March 18^TH.


Summary of 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% (as implied by current pricing on contracts) that the FOMC will vote to lower the benchmark Federal Funds Target Rate by at least 50 basis points (0.50 percentage point) at or before the March 18^TH, 2008 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will be cut by at least 50 basis points at or before the March 18^TH 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 constantly changing, so stay tuned for the latest odds.

--> www.FedPrimeRate.com Privacy Policy <-- >  SITEMAP  <