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Prime Rate

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

Friday, July 27, 2007

Futures Market Now Predicts A Rate Cut by December, 2007

The Fed Funds Futures market has had a sudden and significant change of heart. Very recently, the market was pricing in a very slight chance that the Fed will cut interest rates this year. Right now, however, the futures market is pricing in 96% odds that the Fed will opt to lower short-term interest rates at the December 11, 2007 monetary policy meeting.

Why the sudden change? Well, the availability of large corporate loans -- the loans that have fueled the massive and numerous mergers and acquisitions around the country, and helped to drive the stock market to record highs -- appears to be drying up. And a credit crisis may combine with other factors (like the still-waning housing market) and prompt the Fed to lower interest rates at the end of the year.

Continued bad news from the nation's housing sector is also fueling speculation that the Fed will lower rates before 2008:

  • There's been trouble with subprime loans for many months now, but the latest bad news comes from the prime home-loan market. Countrywide Financial, the nation's #1 home-loan lender, recently reported disappointing earnings, and blamed the poor performance on problems with prime home-equity loans and pay option adjustable-rate mortgages. Countrywide's CEO, Angelo Mozilo, believes that we may have to wait until 2009 for a recovery of the U.S. housing sector.

  • On Wednesday, the National Association of Realtors¬® reported that existing home sales fell by 3.8% last month. When compared to sales 12 months ago, existing home sales were down by 11.4%.

  • Yesterday, the Commerce Department reported that new home sales fell by 6.6% last month. When compared to sales 12 months ago, new home sales were down by 22.3%.

So, what do we know right now? Since predictions related to the Fed Funds Futures market are most accurate within a 45-day window, it's almost a certainty that the Fed will leave the Federal Funds Target Rate (and thus the Prime Rate) at its current level when the group meets on August 7TH. As for predictions that the Fed will lower rates by the end of the year: we'll have to wait until November for the most accurate predictions.

The Latest Odds

As of right now, the investors who trade in Fed Funds Futures have odds at 96% (according to current pricing on contracts) that the Federal Open Market Committee (FOMC) of the Federal Reserve will elect to lower the benchmark Federal Funds Target Rate by 25 basis points at the December 11TH, 2007 monetary policy meeting.

Summary of the Latest Prime Rate Forecast:

  • In all likelihood, the Prime Rate will remain at the current 8.25% after the August 7TH and September 18TH FOMC monetary policy meetings.

  • Current odds that the Prime Rate will be cut to 8.00% after the October 31ST, 2007 FOMC monetary policy meeting: 40% (unlikely)

  • Current odds that the Prime Rate will be cut to 8.00% after the December 11TH, 2007 FOMC monetary policy meeting: 96% (very likely)

  • 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 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, August 3, 2007: The Labor Department releases the Employment Situation report for July.

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