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Prime Rate

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

Saturday, March 15, 2008

Short-Term Rates Very Likely to be Cut By At Least 75 Basis Points On Tuesday

With all the somber economic news in the business headlines lately, one thing is clear: the Fed wants to cut rates aggressively when the Federal Open Market Committee (FOMC) meets on March 18 (Tuesday.)

However, cutting short-term rates aggressively with the concurrent problem of rising prices could hurt the FOMC's credibility. For sure, no one wants a return of 1970's-style inflation.

How bad is inflation right now? Well, to get an idea: crude oil for future delivery finished the week at a staggering $110.21 per barrel, while New York Spot Gold ended the week at $1,002.50 per ounce.

The fed funds futures market is now indicating that the Fed may cut short-term rates by as much as 100 basis points (1.00 percentage point) on March 18. That's very, very aggressive. Is the Fed really going to execute such a large rate cut when so many prominent economists are worried about inflation? Yes, it is.

The Fed is very likely to cut by at least 75 basis points on Tuesday. The twofold justification for such a large cut came on Friday:

  • For some time, the FOMC has stated that it "expects inflation to moderate in coming quarters." The February 2008 Consumer Price Index (CPI) figures bear out the group's assertion. According to the Labor Department report, both the CPI and the core CPI advanced by less than 0.1% on a seasonally-adjusted basis last month. Bottom line: the CPI figures for February are, in essence, the Fed's license to cut aggressively on Tuesday.

  • The U.S. #5 investment bank Bear Stearns is strapped for cash. Bear Stearns stock price fell 47.37% on Friday to close @ $30.00 per share. A year ago, the stock was trading at $143.68. JPMorgan Chase bank borrowed money directly from the Federal Reserve via the Fed's discount window, and then lent that same cash to Bear. The Fed is assuming all the risk for this loan. Bear Stearns may be sold in the near future.

Is the U.S. economy already in recession? We'll have to wait until April 30 for the answer. That's when the Commerce Department is set to release the "advance" Gross Domestic Product (GDP) report for Q1, 2008.

Yesterday, the fed funds futures market had odds at 60% that the Fed will cut the benchmark Fed Funds Target Rate by 100 basis points (1.00 percentage point) at the March 18TH FOMC monetary policy meeting. 40% are betting that the Fed will cut short-term rates by 75 basis points on March 18TH.

Summary of The Latest Odds

As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 100% (as implied by current pricing on contracts) that the FOMC will vote to lower the benchmark Federal Funds Target Rate by at least 75 basis points (0.75 percentage point) at the March 18TH, 2008 monetary policy meeting.

Summary of the Latest Prime Rate Forecast:

  • Current odds that the Prime Rate will be cut by at least 75 basis points at the March 18TH FOMC monetary policy meeting: 100% (certain)

  • 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 constantly changing, so stay tuned for the latest odds.

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