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Prime Rate

also known as the Fed, National, U.S. and WSJ Prime Rate

Monday, July 10, 2006

The Odds On Another Prime Rate Increase Hold at 62%

At the end of last week, The U.S. Department of Labor released the Employment Situation report for June, 2006. The Employment report offers significant insight as to the state of the U.S. job market, so academics, economists, investors and the Fed pay close attention to it. According to the report, average hourly earnings increased by 0.5% when compared to May's numbers; economists were expecting a rise of 0.3%. Also, the U.S. economy added 121,000 jobs in June, while economists were expecting around 185,000 new jobs.

The above figures explain why the investors who trade in Fed Funds Futures still have odds at around 62% (according to current pricing on contracts) that the Fed will elect to raise the benchmark Fed Funds Target Rate to 5.50% on August 8TH.

One might expect the odds to rise because of the 0.5% increase in average hourly earnings, because the Fed tends to raise interest rates when inflation rears it's ugly head, and the higher-than-expected increase in hourly earnings for June translates to "threat of wage inflation" in the Fed lexicon.

However, the lower-than-expected number of jobs added in June balances out the wage inflation threat, because it means that the job market isn't as tight as economists were expecting. When the job market is tight, there's increased pressure on employers to pay higher wages, simply because there are fewer candidates to choose from. And when employees are earning more, they tend to spend more, and that can cause inflation to accelerate.

Simple Summary of the Latest Prime Rate Forecast:

  • Current odds that the Prime Rate will rise
    to 8.50% on August 8, 2006: 62%

The odds related to Fed Funds Futures contracts--generally accepted as the best predictor of where the FOMC will take the cardinal Fed Funds Target Rate--are continually changing, so stay tuned to this blog for the latest odds, especially when The FOMC releases the minutes from the June 28-29 FOMC monetary policy meeting, which should happen on July 20TH, 2006.



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