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Prime Rate

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

Thursday, November 08, 2007

Odds On A Rate Cut for the December 11 FOMC Meeting Now At 70%

Some good news and bad news related to the U.S. economy to report today. First, the bad:

  • Problems related to America's low-quality mortgage loans and financial market liquidity crunch continue to plague the nation. The Dow Jones Industrial Average (DJIA) fell by over 360 points yesterday (all 30 DJIA components declined on the day), as investors got bearish on financial and other stocks that may be affected by subprime debt. Auto giant General Motors lost $39 billion last quarter, the biggest quarterly loss ever for the company, and, believe it or not, subprime debt was a factor (GM owns about half of the financing company GMAC, which has exposure to the subprime nightmare.)

  • The dollar's decline has many economists, academics and investors wondering if countries that hold huge stacks of the currency-- like China and Japan -- will eventually give up on it and rearrange their foreign-asset portfolios. Debt has been propping up the American economy for some time now, and if U.S. Treasuries suddenly become unpalatable, the American consumer ultimately will suffer (this scenario is not likely, however, since dumping dollars would result in a substantial capital loss, and both China and Japan want Americans to keep spending beyond their means on the stuff they make.)

  • Right now, a barrel of crude oil for future delivery costs $96.90, and is widely expected to rise above the $100 level in the near future. The dollar's decline, in cahoots with strong demand and inadequate refining capacity, are all driving prices higher. It's likely that Americans will eventually curtail their spending as a result, which could precipitate a recession.
Good news:

  • Preliminary figures from the Labor Department indicate that non-farm productivity advanced by 4.9% last quarter, while labor costs declined by 0.2%. This bodes well for the American economy and the American consumer: increased productivity and lower labor costs mean an owner can do more hiring or pay his/her current workers more without passing the cost onto the consumer (which would contribute to inflation.) All in all, it's good news for Americans' standard of living.

It looks like the bad news easily outweighs the good, doesn't it? Well, traders in fed funds futures certainly think so, as they are betting that the Fed will once again lower short-term interest rates when the Federal Open Market Committee (FOMC) meets for the final monetary policy meeting of the year on December 11.

The Latest Odds

As of right now, the investors who trade in fed funds futures have odds at 70% (according to current pricing on contracts) that the FOMC will vote to cut the benchmark Federal Funds Target Rate by 25 basis points (0.25 percentage point) at the December 11TH, 2007 monetary policy meeting.

Summary of the Latest Prime Rate Forecast:

  • Current odds that the Prime Rate will be cut to 7.25% after the December 11TH, 2007 FOMC monetary policy meeting: 70% (somewhat likely)

  • NB: U.S. 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.

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