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Prime Rate

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

Wednesday, April 09, 2008

Fed Will Cut Short-Term Rates On April 30; Odds On 50 Basis Point Cut Rising

The fed funds futures market currently has odds at 60% that the Fed will cut the benchmark Fed Funds Target Rate by 25 basis points (0.25 percentage point) at the April 30TH FOMC monetary policy meeting. 40% are betting that the Fed will cut short-term rates by 50 basis points at the end of the month.

Recent economic news influencing the futures market:

  • The U.S. economy got weaker by 80,000 jobs last month, according to the Labor Department's most recent jobs report, while the unemployment rate rose from 4.8% to 5.1%. The total number of nonfarm payrolls lost since the beginning of 2008 now stands at 232,000.

  • Last Wednesday, the U.S. Census Bureau reported that factory orders declined by 1.3% during February 2008. Wall Street economists were expecting a decline of about 0.6%.

  • Last Tuesday, the Institute for Supply Management reported that the Purchasing Manager's Index (PMI) advanced from 48.3 for February to 48.6% for March. Though the recent figure indicates some improvement, any figure below 50% suggests that, generally, the American manufacturing sector is contracting.

  • Also last Tuesday, the U.S. Census Bureau reported that construction spending fell by 0.3% during February 2008. Wall Street economists were expecting a decline of about 1.1%. When comparing 02/2007 to 02/2008, construction spending was down by 3.5%.

  • In prepared remarks before the U.S. Senate Committee on Banking, Housing, and Urban Affairs last Thursday, Fed boss Ben Bernanke made the following comments:

    "...Although the situation has recently improved somewhat, financial markets remain under considerable stress. Pressures in short-term bank funding markets, which had abated somewhat beginning late last year, have increased once again. Many lenders have been reluctant to provide credit to counterparties, especially leveraged investors, and increased the amount of collateral they required to back short-term security financing agreements. To meet those demands, investors have reduced their leverage and liquidated holdings of securities, putting further downward pressure on security prices. Credit availability has also been restricted because some large financial institutions, including some commercial and investment banks and the government-sponsored enterprises (GSEs), have reported substantial losses and writedowns, reducing their capital available to support increased lending. Some key securitization markets, including those for nonconforming mortgages, continue to function poorly if at all.

    These developments in financial markets--which themselves reflect, in part, greater concerns about housing and the economic outlook more generally--have weighed on real economic activity. Notably, in the housing market, sales of both new and existing homes have generally continued weak, partly as a result of the reduced availability of mortgage credit, and home prices have continued to fall. Private payroll employment fell substantially in February, after two months of smaller job losses, with job cuts in construction and closely related industries accounting for a significant share of the decline. But the demand for labor has also moderated recently in other industries. Overall, the near-term economic outlook has weakened relative to the projections released by the Federal Open Market Committee (FOMC) at the end of January. Inflation has also been a source of concern. We expect inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully..."

  • And here's a clip from Ben Bernanke's testimony before the Joint Economic Committee of the U.S. Congress last Wednesday:

    "...Overall, the near-term economic outlook has weakened relative to the projections released by the Federal Open Market Committee (FOMC) at the end of January. It now appears likely that real gross domestic product (GDP) will not grow much, if at all, over the first half of 2008 and could even contract slightly. We expect economic activity to strengthen in the second half of the year, in part as the result of stimulative monetary and fiscal policies; and growth is expected to proceed at or a little above its sustainable pace in 2009, bolstered by a stabilization of housing activity, albeit at low levels, and gradually improving financial conditions. However, in light of the recent turbulence in financial markets, the uncertainty attending this forecast is quite high and the risks remain to the downside.

    Inflation has also been a source of concern. The price index for personal consumption expenditures rose 3.4 percent over the twelve months ending in February, up from 2.3 percent over the preceding twelve-month period. To a large extent, this pickup in inflation has been the result of sharp increases in the prices of crude oil, agricultural products, and other globally traded commodities. Additionally, the decline in the foreign exchange value of the dollar has boosted some non-commodity import prices and thus contributed to inflation. However, the so-called core rate of inflation--that is, inflation excluding food and energy prices--has edged down recently after firming somewhat late last year..."

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 25 basis points (0.25 percentage point) at the April 30TH, 2008 monetary policy meeting.

Summary of the Latest Prime Rate Forecast:

  • Current odds that the Prime Rate will be cut by at least 25 basis points at the April 30TH 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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