Futures Market 97% Certain Prime Rate Will Hold At 3.25% After The January 28 Fed Meeting

On December 16, the Fed took the unusual and unprecedented step of setting a target range of 0% - 0.25% for the benchmark fed funds rate. With regard to short-term interest rates, the Federal Open Market Committee (FOMC) has virtually no place left to go but up. However, with the threat of deflation still looming over an economy in dire need of stimulus, the Fed will very likely opt to keep America's cardinal interest rate exactly where it is. The futures market currently has odds at 3% that the Fed will opt to raise its benchmark rate by at least 25 basis points (0.25 percentage point) on January 28, with 97% in the market betting that the Fed will vote to leave short-term rates alone.

In all likelihood, the following recent economic news had at least some influence on the fed funds futures market this week:

• According to the S&P/Case-Shiller Home Price indices released yesterday, home values took a significant turn for the worse at the start of the fourth quarter. Here are some notable price decline percentages in major U.S. cities for the October 2007 - October 2008 period:
  
  
  • San Francisco: -31.0%
  • San Diego: -26.7%
  • Phoenix: -32.7%
  • Miami: -29.0%
  • Los Angeles: -27.9%
  • Las Vegas: -31.7%
  • Detroit: -20.4%
    
    
    
• Also from yesterday, the Fed announced that at some point in early January it will start buying up mortgage-backed securities; you know, the ones now infamous for a) setting off the global financial crisis, b) contributing much to the development of the current recession and c) taking down some of America's most influential financial institutions.
  
  
• Again from yesterday, The Conference Board announced that its Consumer Confidence Index (CCI) declined to 38.0 for this month (December), which is a new, all-time low for this metric. Wall Street economists were expecting a reading of about 45.0. Clearly, this is not a good omen for consumer spending, which was the principal driving force behind the last economic expansion in the USA, the expansion which, technically speaking, ended exactly one year ago.
  
  The October, 2008 CCI figure was originally reported at 38.0 as well, but it was later revised up to 38.8. For some perspective: October was the month during which the current, global credit crisis peaked.
  
  For the CCI, the baseline "100" score is associated with 1985 survey data.
• Crude oil for future delivery finished 2008 at $44.60 per barrel in New York. That's a decline of $100.69 (69.303%) since crude closed at $145.29 per barrel on July 4, 2008.
  
  
• Bear Market Update: since closing with record highs on October 9, 2007, the Dow Jones Industrial Average (DJIA) has now declined by 5,388.14 points (38.04%), while the broader S&P 500 Index has shed 661.90 points (42.29%). The record high for the DJIA is 14,164.53; for the S&P 500 Index it's 1,565.15.
  
  
  For the year, the DJIA lost 4,488.43 points (33.837%), its worst yearly retreat since 1931. The S&P 500 has given up 565.11 points (38.486%.)
  
  
• One more item from yesterday: the Fed reported the results of its latest, $150 billion money auction, also known as the Term Auction Facility. There were 72 bidders this time around. These 83-day loans will mature on March 26, 2009 and will have an interest rate of 0.2% associated with them.
  
  
• The yield on the benchmark 10-Year Treasury Note ended the year at 2.244%, while the yield on the 13-week Treasury Bill finished 2008 at 0.115%.

If you've been waiting for the Prime Rate to bottom out, it's very likely your wait is over. The one- and three-month LIBOR rates, on the other hand, will likely shed a few more basis points (over time) before settling near the Fed's current upper limit for the fed funds target rate (0.25%.) Stay tuned to this chart for some perspective on how key benchmark rates are trending.

Of course, the LIBOR rates are constantly changing. Stay tuned to this blog for the latest LIBOR news.

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As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 97% (as implied by current pricing on contracts) that the FOMC will vote to leave the benchmark target range for the Federal Funds Rate at its current level at the January 28^TH, 2009 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will remain at the current 3.25% after the January 28^TH, 2009 FOMC monetary policy meeting adjourns: 97% (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 constantly changing, so stay tuned for the latest odds.

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U.S. Prime Rate Is Now 3.25%

U.S. Prime Rate is cut to 3.25%

The Federal Open Market Committee (FOMC) of the Federal Reserve has just adjourned its eighth and final scheduled monetary policy meeting of 2008. Earlier today, the FOMC decided to take the unusual step of establishing a target range for the Federal Funds Rate of 0% - 0.25% (as opposed to using a simple target for the fed funds rate, which heretofore was the FOMC's usual way of setting its most powerful monetary policy tool.) Our bank survey is now complete: American banks have responded to today's action by the Fed by lowering their prime lending rate from 4.00% to 3.25%. Therefore, the U.S. Prime Rate is now 3.25%.

Here's a clip from a press release issued by the FOMC moments ago:

"...The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent..."

A number of large, American banks have already issued a press release announcing that their prime lending rate has been lowered from 4.00 to 3.25%, including:

• The Bank of America  -   +Bank of America 
• Citibank  -  +Citibank US 
• Wells Fargo  -  +Wells Fargo 
• JP Morgan Chase
• Wachovia
• US Bancorp (Parent company of US Bank)
• National City
• et al.
  

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Futures Market 70% Certain Fed Will Cut Short-Term Rates by 75 Basis Points Tomorrow

The fed funds futures market is now 70% certain the Fed will cut the benchmark fed funds target rate (FFTR) by 75 basis points (0.75 percentage point) tomorrow, which basically translates to more likely than unlikely. However, this website's official forecast is the same as it was on December 5^TH: the Fed will cut the FFTR by at least 50 basis points at the December 16^TH Federal Open Market Committee (FOMC) monetary policy meeting.

Yes, it's a very safe bet that the Fed will cut its most important interest rate tomorrow. But will American banks respond by cutting their prime lending rate as usual?

Since the second quarter of 1994, American banks have pegged their prime lending rate to the FFTR. Since that time, a reliable formula for the United States Prime Rate has been:

U.S. Prime Rate = (the FFTR + 3)

On June 27, 2003, the Fed lowered the FFTR from 1.25% to 1.00%. American banks responded by lowering their prime lending rate from 4.25% to 4.00%, but some banks did so grudgingly, complaining that a 4% Prime Rate was too low for them to make a decent profit.

Tomorrow, the Fed will probably lower the FFTR from 1.00% to 0.50%, and if all goes well, American banks will respond by lowering their prime lending rate from 4.00% to 3.50%. But some large banks may resist the rate cut, opting instead to cut their Prime by 0.25 percentage point instead of 0.50, or by not cutting at all and leaving their Prime at 4.00%. This outcome is a very real possibility, as this happened just last week in Canada, the 9^TH largest economy in the world.

It's also important to note that if your bank cuts it's Prime Rate tomorrow, you may not see any change in e.g. the rate you pay on your credit card that's indexed to Prime. Many banks include an interest rate floor in credit card terms to protect themselves from deep rate cuts by the Fed. Bottom line: your credit card account may already be at your card's lowest possible interest rate as a result of the numerous rate cuts the Fed has made since September 2007. Here is an example from an Advanta business credit card agreement:

"...Your Variable Account Rate Index for any billing cycle will be chosen by us from among the Prime Rates published in The Wall Street Journal's "Money Rates" section during the three (3) months prior to the month which contains that cycle's Billing Cycle Closing Date, but will not be less than 5.00%..."

So with this particular business credit card, any U.S. Prime Rate below 5.00% is meaningless.

The good news is that some major banks like U.S. Bank, American Express and the Bank of America don't use interest rate floors with their credit cards (so far.)

Stay tuned to this blog tomorrow. We will conduct our survey, as usual, and we'll update the site as soon as we have confirmation of a rate cut by 23 of America's 30 largest bank holding companies (BHC's.) If some big banks balk, we'll let you know about that too. And please be patient, as confirmation may come very late in the day. Banks will likely be watching each other to see who moves first and by how much.

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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 cut the benchmark Federal Funds Target Rate by at least 50 basis points (0.50 percentage point) at the December 16^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 the December 16^TH, 2008 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.

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Futures Market 80% Certain Fed Will Cut Short-Term Rates by 75 Basis Points At or Before The December 16 Fed Meeting

Responding to this morning's dismal employment situation report, the fed funds futures market is now 80% certain the Fed will cut short-term rates by 75 basis points (0.75 percentage point) at or before the next Fed meeting. In other words, the market now believes that an aggressive, 75 basis point cut is more likely than unlikely. This website's official forecast, however, is that the Fed will cut short-term rates by at least 50 basis points at or before the December 16^TH Federal Open Market Committee (FOMC) monetary policy meeting.

In all likelihood, the following recent economic news had at least some influence on the fed funds futures market this week:

• Earlier today, the Labor Department reported that non-farm payrolls declined by 533,000 during November 2008, and the unemployment rate rose from 6.5% to 6.7%. Revisions to the October and September non-farm payroll figures added more gloom to the day's somber employment news. Non-farm job losses for October were revised up from 240,000 to 320,000, while the September figure was also revised higher, from 284,000 to 403,000. For the week that ended on November 22, 2008, the number of Americans on the dole rose by 89,000 to 4.087 million.
  
• Yesterday saw a couple of aggressive rate cuts in Europe. The European Central Bank (ECB) cut its benchmark rate by 75 basis points to 2.50%, while Britain's central bank, the Bank of England, cut its key lending rate by 100 basis points to 2.00%.
  
• The effective fed funds rate, which is the volume-weighted average rate at which American depository institutions made overnight loans to each other via the Fed, was last reported at 0.16%, and was 0.63% a week ago. The current target for the fed funds rate is 1.00%.
  
• On Wednesday, the Labor Department reported that during the third quarter of this year, American, non-farm productivity improved by 1.3%, but this modest improvement was coupled with a 2.8% jump in labor costs.
  
• On Thursday, the U.S. Census Bureau reported that Factory Orders declined by 5.1% during October. Wall Street forecasters were expecting a drop of about 2.8%.
  
• Earlier today, in its National Delinquency Survey, the Mortgage Bankers Association (MBA) reported that:
  

  
  "...The delinquency rate for mortgage loans on one-to-four-unit residential properties stood at 6.99 percent of all loans outstanding at the end of the third quarter of 2008, up 58 basis points from the second quarter of 2008, and up 140 basis points from one year ago on a seasonally adjusted basis..."

• The yield on the benchmark 10-Year Treasury Note ended the week at 2.657%. The yield on the 91-day Treasury Bill finished the week at 0.01%, and was 0.005% yesterday.
  
• The TED spread, which is the difference between the yield on the 91-day Treasury Bill and the 3-month LIBOR yield, ended the week at 2.18 percentage points. For large, international banks, the TED spread gauges the willingness of these banks to lend money to each other. A TED spread that is somewhere between zero and 1.00 percentage point is considered normal.
  
• Crude oil for future delivery ended the week at $40.81 per barrel in New York. That's a decline of $65.42 (61.583%) since crude closed at $106.23 per barrel on September 5, 2008.

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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 cut the benchmark Federal Funds Target Rate by at least 50 basis points (0.50 percentage point) at or before the December 16^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 December 16^TH, 2008 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.

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Futures Market Still 100% Certain Fed Will Cut Short-Term Rates by At Least 50 Basis Points At or Before the December 16 Fed Meeting

Currently, the fed funds futures market is 40% certain the Fed will cut short-term rates by 75 basis points (0.75 percentage point) at or before the next Fed meeting. In other words, the market isn't too confident about a 75 basis point cut, believing (currently) that such an aggressive move is more unlikely than likely. The market is, however, 100% confident the Fed will cut rates by at least 50 basis points at or before the December 16^TH Federal Open Market Committee (FOMC) monetary policy meeting.

In all likelihood, the following recent economic news has had at least some influence on the fed funds futures market:

• The Business Cycle Dating Committee of the National Bureau of Economic Research has determined that the U.S. economy peaked back in December of 2007, which means that the United States entered into a recession at the beginning of 2008. Click here to view Friday's report.
  
• Earlier today, the Institute for Supply Management (ISM) reported that its Purchasing Manager's Index (PMI) declined for the fifth straight month, from 38.9% for October to 36.2% for November. The last time the PMI was at similar lows was back in the spring of 1982. For the PMI, any figure above 50% suggests that, in general, the American manufacturing sector is expanding, while any figure below 50% suggests contraction for a particular month.
  
  Here's a six month history of the PMI:
  
  

  • June 2008: 50.2%

  • July 2008: 50.0%

  • August 2008: 49.9%

  • September 2008: 43.5%

  • October 2008: 38.9%

  • November 2008: 36.2%

• Also from today, the Federal Reserve reported the results of its latest, $150 billion money auction, also known as the Term Auction Facility. There were 80 bidders. The Fed did not disclose the number of loans awarded via this auction, but the awarded loans will mature on February 26, 2009 and will have an interest rate of 0.42% associated with them.
  
• Last Wednesday, the Commerce Department reported that sales of newly built homes fell by 5.3% during October 2008, and were down by 40.1% for the October 2007 - October 2008 period. The median price for a newly built home fell to $218,000, while the average price slid to $272,300. Click here for historical prices and a chart.
  
• Two Mondays ago, the National Association of Realtors® reported that sales of used homes declined by 3.1% during October 2008. The median cost for a preowned home fell to $183,300 (down 11.3% from October 2007), while the average price for a previously occupied home fell to $224,700 (down 11.9% from October 2007.) Click here for historical prices and a chart.
  
• Last Wednesday, the Commerce Department reported that consumer spending fell by 1.0% during October 2008, the fifth straight decline for this metric.

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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 cut the benchmark Federal Funds Target Rate by at least 50 basis points (0.50 percentage point) at or before the December 16^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 December 16^TH, 2008 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.

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