Assessing the Odds of Another Rate Cut

No one will find encouragement in Tuesday's update on wholesale prices, which posted a troubling 1.1% rise last month. So far, however, the Fed funds futures market is still inclined to see another rate cut when the FOMC meets again on April 29 and 30.

Perhaps, the time has passed for swashbuckling 75-basis-point slashes in the Fed funds. The hour is late when it comes to nipping pricing momentum in the bud. Yesterday's producer price report is just one more clue that it's time for the central bank to pay more attention to pricing pressures bubbling. This idea is all the more compelling when you consider that while the Fed can't do much more at this point to juice the economy via broad changes in interest rates, but it can still act as the defender of last resort when it comes to inflation.

Today, we learned that consumer price inflation rose 0.3% as expected (core CPI rose 0.2%), via the government's update for March CPI, providing the market slight relief it wasn't worse coming off yesterday's PPI numbers. Meantime, it's clear that PPI inflation is still a threat. The 1.1% jump in PPI last month is the highest so far in 2008, and in the upper range for monthly numbers over the last few years. On an annual basis, PPI is now advancing by 6.9%. That's down slightly from the 7.7% peak set in January, but it's still too high to ignore.

Yes, both food and energy costs are the main sources of inflation in yesterday's PPI. The Fed likes to ignore such "noise." That may have worked in the past, but for the moment the idea that core inflation is a better measure of future inflation continues to look outdated. The political realities are such that at some point one of two things has to happen: food and energy costs stop rising or go down; or the Fed attacks the problem with a more hawkish monetary policy. The challenge is deciding when to act, if at all. Sitting around for another six months to get better data no longer looks like a viable option.

In the context of the next few weeks, however, there's still hope that commodity prices will fall, which will give the central bank cover for at least one more crowd-pleasing FOMC announcement. The May '08 Fed funds futures contract is priced in anticipation that a 25-basis-point cut is probably coming. But there's some anxiety hanging over the market. Until and unless the economic slump deteriorates dramatically in the coming weeks, the Fed may feel compelled to stand pat later this month.

In any case, it seems prudent to consider the prospect that FOMC meetings may come and go without a rate cut announcement from here on out. The risk is that the markets haven't yet fully priced in that scenario.

Comments

[Ames Tiedeman:]

I think the Fed is in a box. Cutting rates is not working. This is not a recession that can easily be turned around with rate cuts. The economy has to work out its own problems. More cheap money is not the answer.

2008 Apr 16 07:51 AM

[David Barsan_:]

And if noticed that Eurozone inflation is much higher than they would like it to be, the dollar appreciating doesn't seem like a given either, which would be one way to stem the rise in commodity prices. I agree, the Fed is in a box, and at this point, it seems like further rate cuts aren't going to do anything more to stimulate this economy. I'd rather they focus on CONTAINING inflation, even if they don't start actively fighting it.....

2008 Apr 16 10:09 AM

[bearfund:]

Yes, "containing" inflation is exactly what the Fed did in the 1970s. Interest rates were high, prices were rising rapidly, and expectations were that both conditions would continue for the foreseeable future.

There is a lot of money out there sloshing around. If the Fed wants to have any credibility at all, it will immediately start raising interest rates 50bp per meeting and stop only when we're back near 6%. Why would that be a problem? After all, the credit crisis is over, right?

2008 Apr 16 11:40 AM

[Rich L:]

The FED is done cutting. They put a floor under the market and there is no need to cut further unless we break it. They will stand pat and the market and the dollar will rally when they announce. Commodities will sell off.

2008 Apr 16 11:54 AM

[kurt walter:]

Please, no more rate cuts. The Feds easy money, low interest rate policy was a major cause of the current credit problems.

2008 Apr 16 04:48 PM

[Urbane Gori...:]

Errr.... I lived through the 70's and 80's and remember financing my home at 16% .... You got to remember that **everything** has consequences. If you think home sales are rough now.... Just imagine them with a 16% finance rate... Sorry, that doesn't seem like a good solution to me.. I agree the FOMC is up against the wall here, and let's face it, they don't really have much lower to go anyway... And as noted above, rate cuts do not **seem** to have done anything **yet**.

I'm going to suggest that sometimes the illusion of doing something is better than nothing and perhaps a set of regular 25 point drops would make more sense... At least until we get our turn-around. If nothing else, the financials seem to get a lift when we get a cut and that is where our problem lies.

I'd also suggest that the present administration does something to push for more refinances. Let Paulson 'do lunch' with the banks and under the table give them the choice of 'finding work-arounds for the delinquent', or 'no bailouts' and perhaps endless congressional hearings with rubber hoses and hot lights for the CEOs and CFOs that don't come around.. After all it worked for the Mafia didn't it?

Thx jegan ;-)

2008 Apr 16 09:56 PM

[Voice of Re...:]

The operative word is "yet" I agree probably can't expect the Feds to lower rates more than once more if at all, but you got to give time to all the rate cuts they've made have time to take effect.

The mortgage problem? Simple fix, The feds can buy about half a trillion of so-called "bad" paper and work it off over the next 30 years. Why not, the Bushies blew almost a trillion on a totally unnecessary Iraq war didn't they. What did doing that buy the taxpayer?

2008 Apr 16 11:38 PM

[RKC51246:]

Wish the Fed had some way to influence the Farm subsidies. This ethanol debacle is killing the food prices...in fact, lets not ever have an Iowa caucus.
Also, liberals, quit whining about the buffalo and go for the oil/gas shale in the Dakotas. Or better yet, build some new coal fired generation plants and nuclear reactors . Energy and food prices should moderate once we get these socialist "greenies" out of the mainstream.

2008 Apr 17 08:14 AM

[Hoot85:]

More atomic energy! It's cheap, it's bountiful, and it's safe. Before you all start screaming 3 Mile Island, I've read up on what went wrong that day. That display of destruction is said to have a 1 in a million chance of happening...so we've already got it out of our system! Not to mention, as much nuclear research as we've done by now we should be pretty damn good at it...Just gotta convince the greenies not to be such scaredy-cats.

2008 Apr 17 11:13 PM

[Hoot85:]

By the way, 1 in a million isn't the exact figure...but it is to the same effect intended.

2008 Apr 17 11:14 PM