Saturday, October 14, 2006

Fed will remain paused at 5.25% for the rest of this year and all of next year

My overall assessment of monetary policy remains unchanged.

Market perceptions of Fed policy remain volatile. In fact, last week we saw a dramatic reduction in bets on rate cuts next Spring. The primary contributing factor was public commentary by Fed officials who expressed concern that inflation remains higher than they would prefer. Also, people felt that the economy was a bit stronger than the pundits had been leading them to believe.

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 0% chance of a cut at the December meeting and even a 2% chance of a hike. Futures indicate only a 10% chance of a cut by the March meeting, a 54% chance of a cut by the June meeting, and a 76% chance of a cut by the July meeting. But there is no longer any hint of a second cut. I personally don't concur with these 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, not to mention commentary and sentiment, unfolds. Further, the "betting" on any last Fed move is usually more of an insurance hedge than an outright bet, more of a "just in case I'm wrong" kind of "bet". Finally, Fed funds futures are not a very reliable indicator more than 45 days into the future.

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 for all of 2007.

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.

-- Jack Krupansky


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