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Rate Cut Odds Diminish

The analysis below is from Tony Crescenzi at TheStreet.com. I thought his analysis is important enough to the continued bull market in stocks to include here…

Recent strength in economic news, continued buoyancy in commodities prices, and the Fed’s de facto inflation-targeting regime have convinced the bond market that no interest rate cut is in the offing. If these conditions continue, rumblings about an interest rate hike are likely to develop.

Today’s stronger-than-expected economic news has further reduced the chances of an interest rate cut. The odds of a cut are now virtually non-existant for this year.

The market is priced for no chance of a hike at either the June 28 FOMC meeting or the Aug. 7 FOMC meeting.

For the Sept. 18 FOMC meeting, the market is priced for just 2% odds of a cut.

For the Oct. 31 FOMC meeting, the market is priced for 8% odds of a cut.

For the final meeting on Dec. 11, the market is priced for just 16% odds of a cut, down from 30% yesterday, 48% a week ago, and 100% a month ago. There were also small odds (24%) of a second cut built in a month ago to the end-of-year scenario.

Eurodollar contracts indicate that at the end of 2008, investors expect the fed funds rate to be around 5.15%, about 65 basis points higher than what was expected in the midst of the subprime worries in February.

The removal of rate cut odds paves the way for the pricing in of rate hike odds. A strong set of economic news combined with higher-than-expected inflation news would cause some to believe that a rate hike might be next. In this case, the bond selloff would enter a more virulent phase for the stock market and for other risk assets, shifting from the lauded “no recession” variety to the “Fed might tighten” variety, hence spurring corrections in markets.