Saturday, August 04, 2007

Despite mortgage woes, Fed still on track to keep target rate at 5.25% for the rest of 2007 and probably well into 2008

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

Despite all of the chatter about housing and mortgage "woes" and an alleged "credit crunch" and some allegedly weak economic data, the economy still has plenty of underlying strength and inflation is still problematic, so the Fed remains on track to keep the fed funds target rate paused at 5.25% for the rest of the year and probably well into 2008.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

  • August 7, 2007: 26% chance of a cut -- slam dunk for no change
  • September 18, 2007: 46% chance of a cut -- flip a coin, but leaning towards no cut
  • October 30/31, 2007: 84% chance of a cut -- cut is likely
  • December 11, 2007: 100% chance of a cut and 38% chance of a second cut
  • January 2008: 100% chance of a cut and 82% chance of a second cut -- second cut is likely
  • March 2008: 100% chance of two cuts and 10% chance of a third cut
  • May 2008: 100% chance of two cuts and 36% chance of a third cut
  • June 2008: 100% chance of two cuts and 50% chance of a third cut -- flip a coin, but leaning towards no third cut

Note: Studies have shown that the fed funds futures market only has a high degree of forecast reliability about 30 to 45 days out (high out to 30 days, only modest reliability out to 60), so those probabilities beyond September are shaky at best and could easily change very dramatically.

What we saw last week was a simple knee-jerk reaction to short-term data volatility. Wait a few weeks and the picture will change again.

-- Jack Krupansky

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