Will the Fed cut by three-quarters of a point this week? (updated)

Although some people continue to chatter as if it were likely that the Federal Reserve will cut its federal funds target rate by three-quarters of a point, it appears unlikely at this point in time. Instead, the highest likelihood is that the Federal Open Market Committee (FOMC) will cut its target rate by a half-point, from 1.50% to 1.00%, at its meeting on Wednesday, October 29, 2008.

Fed funds futures indicate a 100% chance of a half-point rate cut and only a 46% chance of a three-quarters point cut.

It will be quite interesting to see how, if, and when this cut plus the last half-point cut filter into money market fund, money market account, and CD rates. The good news is that a fair number of banks are very serious about attracting deposits, so they may be a little hesitant to drop rates too promptly. On the money market fund front, the issue is the commercial paper market and worry about redemptions. I would note that the new Federal Reserve Commercial Paper Funding Facility (CPFF) went into operation on Monday, October 27, 2008, and that could push commercial paper rates down, eventually. Actually, the initial CPFF offerred rate was 3.88% for asset-backed commercial paper and 2.88% for unsecured comercial paper (1.88% plus a 1.00% surcharge), which are substantially higher than average money market fund yields.  CPFF does not affect money market funds directly since issuers of CP sell directly to the Federal Reserve, but it will indirectly affect the money markets by soaking of excess supply of CP, which might then have the effect of pushing yields down. The goal of CPFF is not to reduce the investment opportunities that money market funds see, but simply to act as a "backstop" and assure that CP issuers can sell as much paper as they need to sell independent of the day to day needs of the money market funds to actually buy CP on any given day.

-- Jack Krupansky