FOMC Alert: Traders Now Looking At Possible Rate Cuts

Today wasn’t just a bad day for financial stocks and for the markets in general.  It may have been a real game changer.  But interestingly enough, there is now roughly a 32% chance that the FOMC will announce a rate cut at its meeting Tuesday.

You will want to check your own math here on the CBOT Fed Fund Futures Page as this was done on the fly and not at the office.  On Friday, the chance of a rate cut was only about 7% as SEPT-2008 fed fund futures were $98.0175.  What is funny now is that the further yougo out on the curve, the more likely a rate becomes.  If you go to OCT-2008, there is now a roughly 68% chance that we’ll see a rate cut of 0.25%.  In NOV-2008,we have an 88% chance of a rate cut of 0.25% versus versus a 26% chancejust on Friday.  And if you go to DEC-2008 or into 2009, we cross thegreater than 100% mark for a 0.25% rate cut.  That was only a 34%chance as of Friday.  The peak month as of today is April-2009, and bythen there is even about a 76% chance that the rate cutscould be as much as 0.50%.  None of this is assured.  It is solelybecause of today’s financial stock sector malaise withinstitutions on the brink of implosion and failure.

Wasn’t it just a couple weeks ago that everyone was talking about RATEHIKES?  That is Wall Street for you.  But now you have seen theseizure of Fannie Mae and Freddie Mac.  You have seen the government-backed bailout/buyout of Bear Stearns, the quick-sale of Merrill Lynch,the Chapter 11 filing of Lehman, and an AIG that looks financially lessable to sustain itself than if it had accountants and complianceofficers from the dementia wards.

Now there is just one small problem.  The rate cuts, evenif they do come to pass, are not going to help.  All of these institutions need majorde-leveraging to become healthy again.  They need borrowersto pay for their mortgages, their car loans, their home equity loans,and their credit card loans.  They also need unlimited amounts ofliquidity available for them to borrow. 

Unfortunately, there just isn’t enough cash and liquidityto go around for everyone.  Even if this round gets resolved, there arefundamental problems and they cannot just be gotten out of byannouncements that portfolios and units are for sale.  Lower ratesaren’t going to help the problem.

Jon C. Ogg
September 15, 2008