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Prime Rate

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

Friday, December 22, 2006

Probability of A Rate Cut for The March 21, 2007 FOMC Monetary Policy Meeting Drops to 17%

If you're happy with the current U.S. Prime Rate level -- 8.25% -- then we have good news for you: it's not budging any time soon.

A number of key economic reports were released by the government this past week, including Housing Starts, PPI, GDP Final, Leading Economic Indicators, Durable Goods Orders, Consumer Sentiment, Consumer Spending, and the Philadelphia Fed's Business Outlook Survey. The economic picture is still mixed, which is nothing to get excited about, but, on the positive side, no one is predicting economic disaster for 2007: many economists and academics are forecasting that the U.S. economy will expand by about 3.0% next year. Of course, moderate growth is good news from a price stability perspective, and it should also translate to short-term interest rate stability.

Bottom line: if the Fed does decide to cut interest rates next year, it's not likely to happen before the third quarter of 2007.

Right now, the biggest drags on the U.S. economy are manufacturing and housing:

  • Bad news out this week, from a manufacturing perspective : the folks at Toyota are planning to produce an astonishing 9,420,000 vehicles in 2007; General Motors may end up as the global #2 auto manufacturer if the top brass at Toyota realize their 2007 goal.

  • Bad news out this week, from a housing perspective: According to the final, third-quarter GDP report released yesterday, residential fixed investment fell by 18.7% during Q3, 2006; in the preliminary GDP report released last month, the figure was reported at 18.0%. Furthermore, the Center for Responsible Lending recently forecast that approximately 1 out of every 5 subprime mortgages originated during the past 2 years will end up in foreclosure, and losses for subprime mortgage holders may climb as high as $164 billion over the next several years -- mainly in the form of lost home equity.

The Latest Odds

Of course, investors have reacted to this week's news and economic reports. As of right now, the folks who trade in Federal Funds Futures have odds at around 17% (according to current pricing on contracts) that the Federal Open Market Committee (FOMC) will elect to lower the benchmark 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 January 31ST FOMC monetary policy meeting.

  • Current odds that the Prime Rate will be cut to 8.00% at the
    March 21ST, 2007 FOMC monetary policy meeting: 17% (unlikely)

  • NB: 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 Federal Funds Target Rate -- are continually changing, so stay tuned for the latest odds. Odds may experience a significant shift after the release of the following economic reports:

  • Wednesday, December 27, 2006: The Commerce Department releases their report on November New Home Sales.

  • Wednesday, December 28, 2006: The National Association of Realtors¬® releases the November Existing Home Sales report.

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