Fed will remain paused at 5.25% for the rest of this year and next -- no recession no year

Despite all the chatter about the economy slowing, a potential recession next year, and the Fed needing to lower interest rates next year, my read of the state of the economy is that the underlying economy is significantly stronger than many pundits insist. Housing will moderate a bit more but remain relatively robust, there won't be a recession next year, and the Fed will not feel the need to change interest rates at all for the rest of this year and all of next year. Sure, all of this is subject to change as the global economy evolves, but that's what the current information about the economy is telling me.

Admittedly, GDP could come in relatively weak in Q3, Q4, and Q1, as the moderation of the housing boom gets digested and we had high commodities prices in Q3, but we should see a nice rebound come Spring. I wouldn't be surprised to see one or two of those quarters come in at growth below 2% or even 1%, but even 1% GDP growth for all three quarters wouldn't be enough to get the Fed to ease since the whole point of the rate hikes was to get rid of the excess growth and return the economy to organic growth that isn't based primarily on too-easy money.

As of Friday, Fed funds futures contracts indicate a 0% probability of a further rate hike at the October FOMC meeting and only a 2% chance of a cut. Futures indicate a 10% chance of a cut at the December meeting, a 60% chance of a cut at the March meeting, 100% chance of a cut by the June meeting with a 20% of a second cut as well, and 54% chance of a second cut by the July meeting. I personally don't concur with those odds, but that is how a lot of people are actually "betting." I would simply note that such betting can change on a moment's notice as economic and financial data unfolds.

I suspect a lot of those bets are based on a presumption that the housing sector will seriously collapse and reflect more of a "worry" than a steely analysis. I would note that mortgage rates are still quite low and are driven more by the extreme amount of cash sloshing around looking for a return (in Mortgage-Backed Securities - MBS) than the Fed's monetary policy. Banks are primarily originating and then securitizing home mortgages rather than capitalizing them with money from the Fed. Sure, the speculators, flippers, and and poor credit risks may be driven from the housing market, but that's all for the better anyway, and I suspect that they were never as big a factor as pundits insist. My estimation is that the last of the "weak" hands will be out of the housing market in another three months, by the end of the year.

The simple fact that short-term T-bills are yielding significantly less than the Fed funds target rate (4.90% for a 3-month T-bill, 5.00% for a 6-month T-bill, and 4.62% for a 28-day T-bill versus the 5.25% Fed funds target rate) shows how dramatically the availability of money exceeds the demand for money. It also shows the sterling credit quality of the U.S. Treasury even in the face of so-called "massive" federal budget and national trade deficits.

My recent Fed commentary will probably hold for some months to come.

My view is that the Fed will keep their fed funds target rate paused at 5.25% for at least the rest of the year, and probably for the entire coming year.

It is also my view that there will not be a recession next year, nor even enough of a growth slump to trigger a Fed rate cut.

Upcoming Fed FOMC meetings:

• October 24/25, 2006
• December 12, 2006
• January 30/31, 2007
• March 20/21, 2007
• May 9, 2007
• June 27/28, 2007
• August 7, 2007
• September 18, 2007
• October 30/31, 2007
• December 11, 2007

-- Jack Krupansky