Counting Chickens: How Much Is the Market Already Pricing In a Fed Funds Rate Cut?

The most anticipated event risk next week is the Federal Reserve’s interest rate decision. Going into the meeting, the market is now pricing in a 68 percent chance of a 50bp rate cut and a 32 percent chance of a 75bp rate cut.

This indicates that the market believes 25bp will be the minimum that the Fed eases on Wednesday. We believe that a 75bp rate cut will be a too aggressive because it leaves the central bank with next to no room to cut interest rates in case things get worse – and they will.

The 3 most realistic options are:

1. 50bp rate cut
2. 50bp coordinated easing along with other central banks
3. 25bp rate cut

A coordinated easing will probably have the most significant impact on the financial markets and given the drop in oil prices and the deterioration in European economic data, the ECB and the BoE may not be opposed to this option.

Although the Fed may have considered a 25bp rate cut earlier this week, they know that if they under deliver now, the consequences for the equity market could be severe. A larger interest rate cut could put a stop to the dollar’s rally.

Comments

[Pat P:]

Hi,

The market is actually pricing in a 100% chance of a 50bp cut and a 26% chance of a 75bp cut at the upcoming meeting.

Nov Fed Funds price 99.065

2008 Oct 25 09:04 AM

[pochovilla:]

and the market will rally for 1hr, 6 hrs or 1 day before giving back any gains?

2008 Oct 25 01:08 PM

[holhamjb:]

Would someone mind explaining how these percent chances are calculated, i.e., that "the market is now pricing in a 68 percent chance of a 50bp rate cut and a 32 percent chance of a 75bp rate cut"? Thanks.

2008 Oct 25 02:44 PM

[User 265729:]

Ms. Lien,

Always a pleasure to read your articles. Sadly, it doesn't matter if the Fed goes to zero. They could start PAYING people one or two percent... It simply doesn't matter.

As pochovilla (above) said, How long will it last? The shelf-life for all of these tricks gets shorter and shorter (and more expensive). The $700 billion bailout brought a couple of days relief on anticipation of the vote, but when the vote occurred, it was already factored in and the markets sank.

I saw one estimate that they would need somewhere around $150 trillion to bail out the world economies to prevent a total collapse, as these derivatives start to unwind. Simply, there is not that much money available -- we are toast! There is NO WAY OUT. It is a question of WHEN, not IF.

You add to this, all of the firms in the United States that are built on *intangibles* -- a nice word for a company that is $500 million in debt with $1 million in assets when against a wall. Ans there are millions of these companies in the United States...Millions...

BTW, although the newspeak types call this economic condition unwinding, I prefer to call it unraveling, since this was a giant fraud that was allowed to occur, and was in fact encouraged by political leaders, as well as people like Alan Greenspan (may he burn in a special hell for bad economists).

2008 Oct 25 04:04 PM

[User 265729:]

holhamjb:

It is like betting on a future event and the probability that it may occur and how the market would react to that event.

Let's see... It would be like betting on a horse that runs really well on a wet track... You would want to wager on the probability that it would be raining at post time. If it's been raining and there is a 100 percent chance of rain, then the odd spreads were built-in at post time. If there is a sudden cloudburst that nobody saw coming... etc. Does this sorta make sense holhamjb?

2008 Oct 25 04:11 PM

[whisperonth...:]

It's all a gamble. A stock can be really reliable over the years, show promise, have a lot going for it, etc. but as soon as an analyst writes one article saying that they are lowering their rating for that stock, everyone believes them and they sell. Maybe they lost an argument, or a bet. Maybe they sold the stock just before it went up? Or bought it just before it went down? And maybe that stock isn't bad after all, just had a slow day. We all gamble every day, knowing that we could lose it all with one run on a bank... for no reason but that an analyst said so.

Perhaps my inexperience is showing, but by not listening to analysts, by researching companies on my own and looking for those things that are important to me, I've at least managed to maintain a somewhat level portfolio this year. It's interesting to read what people write, but I don't base my stock buys/sells on that. I've sold a few that I should have kept, ignored a few that later proved to be exceptional, and lost some on stocks that should have been good, but I didn't do any of it based on an analyst's view.

2008 Oct 25 05:03 PM

[highlarche:]

Gold will fly on a 50 cut

2008 Oct 25 05:07 PM

[User 265729:]

Whisper On the Wind:

Analysts have been more into the same and scam of pumping-up stocks that had no value and giving their companies and investments glowing ratings when they should have all been STRONG SELL.

If you have a minute, go to the U.S. House of Representatives website and check out what the clowns at Moody's were doing and saying...

Stock markets in general and U.S stock markets in particular have been a giant sham -- a form of legalized crime brought to you by politicians and fat - greedy CEO's.

The public is sick of all of them.

Analysts and rating agencies... They are all a crock of you know what!

They've been painting too rosy of a picture when they should have been screaming FIRE!

2008 Oct 25 05:15 PM

[soapnuts:]

Well, geesh folks. My, my, my we certainly have a lot of doom and gloomers out there. Some of these sound like you're mad at other people because of your own mistakes (and holes you're in). Did you get stung? The handwriting has been on the wall for a long, long time. Two years ago, when my 22 yr. old nephew (who just started a job in telemarketing) bought a $250K house, I knew then this was just around the corner. The piper is ALWAYS paid. Bet you weren't complaining when you were making money even though this was happening. Right? Blame yourself and get over it. I hate whining and finger pointing. There's only ONE person responsible for where YOU are today. Need I say who? Cheer up though. This won't last forever, or better yet, there are always survivors. Personally, I'll be one. It's attitude my friends - all attitude (with a little foresight and wisdom thrown in). Good luck to you all.

2008 Oct 25 09:51 PM

[Cleopatra:]

State it either way you can. Makes a difference not.

2008 Oct 26 03:39 PM