Betting on a Rate Pause
A: The fed meets next week to decide the next move with monetary policy, and I have to say that this meeting is by far the most confusing one in the past 2 years as to whether or not there will be an 18th consecutive 1/4 point rate hike or a pause. The markets are betting on a pause. Here is the skinny!
FED FUNDS FUTURES ARE 36% FOR HIKE & 64% FOR A PAUSE
The fed funds futures contracts are bets made by traders as to whether or not the fed will hike at their next meeting. Right now traders are betting on a pause!
This is mainly due to Bernanke's speech to Congress a few weeks ago where he mentioned that he believes a 'cooling economy will help keep inflation pressures at bay'. I do not agree but then again he is Big Ben and I am UrbanDigs.
All in all, the fed funds futures are betting on a PAUSE!
EQUITIES MARKETS RALLY AHEAD OF FED MEETING
The equities markets are rallying in anticipation of a pause at next week's meeting. A party too early? Perhaps! However, with the fed funds futures predicting a pause, money is following suit in equities. Should the fed pause, a slight temporary rally in stocks should be expected as the recent rally is already pricing in a pause. Should the fed raise 1/4 point, stocks will fall. Should the fed raise 1/4 point and issue dovish remarks (that means they mention the rate hikes are pretty much done), the equities markets will probably fall at first but then rally after.
All in all, the stock market is betting on a PAUSE!
BOND PRICES RISE AS YIELDS FALL
The bond market has experienced a runup in prices and a dropoff in yields as bond traders are predicting a pause at next weeks fed meeting! Remember, as bond prices rise yields fall and vice versa.
The 2YR, 5YR , and 10YR treasury notes all had a significant drop in yields as they predict an end to the 2+ year interest rate hike campaign and bet on a upcoming US recession (via an inverted yield curve) where the fed will have to cut rates to stimulate the economy.
All in all, the bond market is betting on a PAUSE!
MORTGAGE RATES & US DOLLAR DROP
Freddie Mac reports 30-year sinks to 6.63% on weak GDP numbers, warns that number will drift over next few months. The average rate on 30-year fixed-rate loans fell to 6.63 percent for the week ending August 2 from 6.72 percent the week before.
The weak GDP # technically means inflation is not as bad as first thought, that the fed can pause with a slowing economy, and therefore mortgage rates reacted as such.
Also, the US dollar has been getting hit as currency traders devalue the greenback as most other tradable markets predict a rate pause at next weeks meeting. Recall that the US dollar rises as the fed raises the fed funds rate and makes fixed asset investments more attractive! With a pause now predicted, the dollar is weakening.
All in all, lending rates and US currency traders are betting on a PAUSE!
MY THOUGHTS
The case for another 1/4 point hike is certainly very compelling given the recent jump in core inflation and the surprising strength in US manufacturing data; which shows inflation rising and US economy still strong. Recall that Bernanke started this whole PAUSE chain of thought by saying that a slowing US economy will keep inflation at bay! Oh boy, I hope he's right because most economists would agree that inflation is far worse than a recession, and should take priority as monetary policy is set to control price stability.
This is how I see it:
With the core inflation number well above the fed's stated comfort zone I just don't see how they can solely rely on a predicted slowdown in the US economy to ease inflation pressures on its own. An 18th consecutive 1/4 point rate hike is needed and will show the markets the hawkish nature of the fed and their willingness to fight inflation. That would be the right move. A fed funds rate of 5.5% is NOT restrictive historically speaking as we were at 6.5% in the mid 2000 when the fed tried to slow down the booming dot com equity markets. All homeowners should keep an eye on next week's move as it will eventually affect their monthly mortgage payments!
Comments (4)
Well the jobs report came in MUCH weaker than first thought as unemployment rate rose to 4.8%. Treasury prices soar on the news as yields fall and further back the likelihood of a PAUSE at next weeks fed meeting!
Posted by Noah | August 4, 2006 2:19 PM
PIMCO's Gross: "Fed will definately Pause"!
http://money.cnn.com/2006/08/04/news/economy/fed_gross.reut/index.htm
I happen to agree with that as its hard to go against what all the markets are betting on. However, one must keep in mind what I have been saying for the past 6 weeks:
A PAUSE DOES NOT MEAN THE FED WONT RAISE AGAIN IN THE FUTURE!!!
It is very possible, even likely the fed will have to raise rates again down the road, at least a little. So, don't think that a pause means rates will start going down by years end. I seriously doubt that scenario will play out!
What do you think?
Posted by Noah | August 4, 2006 5:01 PM
I hope they don't raise the rate any more. If they do, I'm thinking home prices will fall further.
Posted by Richard Johnston, REMAX | August 5, 2006 10:56 PM
I think we are at the point of no return regarding home prices.
I think what is at stake here is Bernanke's credibility.
Once people realize by Dec '06 that his pause had no effect on re-inflating the RE market, there will be major concern. Which = less consumer spending and more price drops by spring.
By then, the dollar would be worth what? and gold worth $1,000 an oz?
No, it would be in our best collective interests to have a deflationary event than a hyper-inflationary event. Bitter medicine, yes, but its worse to chase our debt like a dog chases its tail.
Posted by jmr | August 6, 2006 2:44 AM