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Prime Rate

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

Friday, March 09, 2007

Probability of A Rate Cut for The June 28, 2007 FOMC Monetary Policy Meeting Now At 32%

Are we headed for a recession? Of course, we'll get one eventually. But will we get one within the next 12 months?

Well, according to a yield-curve model created by the Fed, there's a 50/50 chance that the U.S. economy will contract for two quarters. Furthermore, former Fed boss Alan Greenspan recently predicted a one-in-three chance that the U.S. economy will sink into recession at some point this year.

And the bad news from the subprime mortgage industry keeps coming: New Century Financial Corporation recently reported that the company isn't accepting new loan applications, because its creditors won't let it. Shares of New Century Financial Corporation (NEW), which were trading in the $50 range during mid-2006, closed at $3.22 per share today.

  • The problem with the housing market is that it was strong for a number of years, thanks in no small part to very low interest rates. The hot housing market led to a rise in property values, which then prompted lenders to relax lending standards based on the reduced risk involved with home loans (higher home values = lender can recover more cash if the borrower defaults.) Now that home prices have been stagnant or falling in many regions across the country, lenders are now more stringent with their lending practices, which translates to fewer people qualifying for mortgages, which in turn contributes to the slowing housing market.

    Many home buyers who bought via an adjustable rate mortgage (ARM) assumed that home prices would continue to climb, which would make it easy to refinance once the loan resets ("resetting" is when the attractive, low-monthly-payments period -- also known as the "teaser" period -- ends, and the higher monthly payments begin.) Folks who opted for an ARM usually planned to either refinance before the loan reset, or sell the property before the loan reset. But if the value of a home doesn't rise significantly over time, then both selling and refinancing can be difficult due to lack of equity. Furthermore, if the borrower's credit score declines during the teaser period, then finding a good refinancing deal becomes much harder.

Ordinarily, news like the above would translate to an increased likelihood that the Fed will cut short-term interest rates later this year, but today's jobs report nullified the negative economic news, and led to a decreased likelihood that the Fed will lower rates before mid-2007.

According to the Labor Department's February Employment Situation Report, the unemployment rate dropped from 4.6% to 4.5%, and 97,000 new jobs were added to the American workforce. Furthermore, the January new jobs count was revised up from 111,000 to 146,000, and the December, 2006 figure was bumped up from 167,000 to 226,000.

The Latest Odds

As of right now, Fed Funds Futures traders have odds at around 32% (according to current pricing on contracts) that the FOMC will elect to lower the benchmark Federal Funds Target Rate by 25 basis points at the June 28TH, 2007 monetary policy meeting (odds on a rate cut for June were at 75% a week ago.)

Summary of the Latest Prime Rate Forecast:

  • Current odds that the Prime Rate will be cut to 8.00% after the June 28TH, 2007 FOMC monetary policy meeting: 32% (not likely)

  • Current odds that the Prime Rate will be cut to 8.00% after the August 7TH, 2007 FOMC monetary policy meeting: 79% (somewhat likely)

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

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 reports:

  • Thursday, March 15, 2007: The Labor Department releases the Producer Price Index (PPI) report for February.

  • Friday, March 16, 2007: The Labor Department releases the Consumer Price Index (CPI) report for February.

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