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Prime Rate

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

Saturday, December 02, 2006

Probability of A Rate Cut for The March 21, 2007 FOMC Monetary Policy Meeting Hits 80% On ISM Manufacturing Report

The odds that the Federal Reserve will cut interest rates by the March 21, 2007 Federal Open Market Committee (FOMC) monetary policy meeting are now at 80%, and will likely rise in short order. In fact, investors have recently priced in 28% odds that the Fed will elect to cut the benchmark Federal Funds Target rate by 25 basis points at the January 31, 2007 monetary policy meeting.

The latest probability shift comes as a result of today's Institute for Supply Management's (ISM) report on November manufacturing: the November Purchasing Manager's Index (PMI). The PMI for last month was 49.5%. Any figure above 50% indicates an expanding factory sector; below 50% indicates that U.S. manufacturing is contracting. Last month marked the first time the index fell below 50% in years.

A rate cut by next year is almost a certainty now, not only because the waning manufacturing sector makes up twelve percent of the U.S. economy, but also because of this statistic: the Fed has always cut interest rates within a year after the PMI has dropped below 50%.

Though many Fed officials are still warning that inflation may still be a problem moving forward, the economy is nevertheless putting considerable pressure on America's central bank to lower interest rates. Key sectors are hurting: housing, cars and now manufacturing, and more economists are abandoning hopes of a soft landing, and are now thinking recession. Adding further pressure today: the yield on the 10-year treasury note fell to 4.425%.

The Latest Odds

As of right now, the folks who trade in Fed Funds Futures have odds at around 80% (according to current pricing on contracts) that the FOMC will elect to lower the Federal Funds Target Rate by 25 basis points at the March 21ST, 2007 monetary policy meeting.

Summary of the Latest Prime Rate Predictions:

  • In all likelihood, the Prime Rate will remain at the current 8.25% after the December 12TH FOMC monetary policy meeting.

  • Current odds that the Prime Rate will be cut to
    8.00% on January 31ST, 2007: 28% (unlikely)

  • Current odds that the Prime Rate will be cut to
    8.00% on March 21ST, 2007: 80% (somewhat likely)

  • NB: Prime Rate = (The Fed Funds Target Rate + 3)

The U.S. Prime Rate (WSJ Prime Rate) is currently 8.25%.

The odds related to Fed 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:

  • Friday, December 8, 2006: The Labor Department releases the Employment Situation report for November



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