Will The Cut Be 25 Or 50 Basis Points?
Until last Tuesday, many market observers, including the writer of this
column, believed that the Federal Reserve would keep interest rates low by “jaw
boning” yields lower, that is, using verbal threats of monetary easing to push
rates lower. Typically, officials who use this approach to effect their policy
goals will use threats sparingly, so as not to exaggerate swings in the markets
later down the road when it becomes apparent to participants that these threats
will not come to fruition.
Last Week Mr. Greenspan showed the market his cards.
On June 2, when addressing a group of European Central Bankers via satellite,
Alan Greenspan, for the third time in a month, basically said that the Fed
remains vigilant against deflation “the chances of inflation reemerging in the
near future are very small.” In his address, the chairman also gave his most
upbeat assessment of the economy since the end of the war in Iraq when he stated
that, “The marked moves in the stock market in recent weeks and especially in
the credit markets is suggestive of a fairly marked turnaround.”
Since last Tuesday, the July Fed Funds future contract has ignored every bit
of news that has been thrown its way– including a much higher-than-expected
ISM; a better-than-expected payroll number; improving outlooks from bellwether
companies across many industries; Mr. Greenspan’s own upbeat remarks about the
economy; and an S&P that was testing 1007 last Friday. The contract
has broken through its March 10 highs, when uncertainty about the war in Iraq
was at its zenith, and is now completely pricing in a 25 basis point cut while
assigning a 65% probability to a 50 basis point cut by the FOMC at its meeting
on July 25. Â
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So at this point, a rate cut is pretty much a done deal, as the Fed doesn’t
usually like to catch the markets off guard, and the question is 25 of 50
points. I’ll be watching the markets to let you know.
Edward Allen