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Wednesday, September 20, 2006

Tomorrow's Fed Meeting: Will They Cut Rates?

From Ticker Sense

Tomorrow's Fed meeting seems to us like the most unanticipated Fed meeting of recent memory. Consensus is all but certain that the Fed will stand pat and leave rates at 5.25%. However, an interesting thing occurred in the futures market today, where at sometimes, the market was actually anticipating a slight chance of a cut.

Without going into too much detail, the odds the market places on what the Fed will do at a given meeting can be calculated using the Fed fund futures market. For tomorrow’s meeting, if the market is anticipating a 100% chance of no change, then the September Fed funds contract should trade at 94.75 (100 – 5.25%) with 5.25% being the Fed funds rate. Therefore, any trade above 94.75 implies a lower Fed funds rate, while any trade below 94.75 implies a higher rate. The further the contract trades away from 94.75, the greater the odds the market is placing on a Fed move. As the intraday chart below details, during the day today, the front month contract traded above 94.75 which implies that someone was actually betting that the fed would cut rates tomorrow.

Admittedly, the contract only traded slightly away from 94.75, but it further drives the point that the Fed is done. Who knows, with Fed Governor Mishkin (an ardent believer in the predictive powers of the yield curve) participating in his first meeting as a voting member, maybe someone thinks that a rate cut isn’t so far out of the question afterall.

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