Saturday, October 28, 2006

Fed will remain paused at 5.25% until at least 2008

My overall assessment of Fed monetary policy remains unchanged:

My view is that the Fed will keep their fed funds target rate paused at 5.25% for 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.

The weak GDP report scared a lot of people into believing that the Fed will have no choice but to cut rates by a quarter to a half point next Spring or Summer, but don't believe it. GDP is a rear-view-mirror report, and says nothing about the economy today or in the coming months.

As of Friday, Fed funds futures contracts indicate a 0% probability of a further rate hike at the December FOMC meeting and only a 2% chance of a cut. Futures indicate a 6% chance of a cut at the January meeting, a 30% chance of a cut by the March meeting, a 96% chance of a cut by the June meeting, and a 100% chance of a cut by the August meeting. Futures also indicate a 52% chance of a second cut by August and a 100% chance of a second cut by December 2007. 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.

-- Jack Krupansky

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