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Predicting The Fed’s Next Move (With ChartJunk)

The Cleveland Fed posts some really interesting charts [1] that track the probability of their next moves using options on federal funds futures using data from the Chicago Board of Trade [2]. Here’s a good summary of how it works [3].

The charts are really cool (but full of chartjunk [Wikipedia] [4]) and provide insight into the Fed’s direction at their October and December meetings.

The probability of the Fed holding rates at 5.25% is very high and all other choices are close to zero.

The probability of holding at 5.25% is less in December and there was some uptick in the probability that the rate could move down to 5%. This is something to watch for as economic stats are released this fall. More bad news will improve the probability that 5% is the new federal funds rate change. Although I like those odds, right now it doesn’t look like it will happen unless more bad news is on the way.

However, a falling federal funds rate is not necessarily good for housing. If the fed feels it needs to drop rates, it is because housing is fairing poorly and consumer spending is weak. Lower mortgage rates would be caused as a byproduct of the fed rate drop but would likely only provide hope that the end of the housing doldrums is near. Refi’s may rise as a result, which will help some whose mortgage ARM’s are about to reset.

As Randall Forsyth in this week’s article Looking for Shelter, But Where? [Barrons (subsc)] [5] said:

Just as the regulators slam on the credit brake, the Fed might have to step on the gas by beginning to cut the funds rate. Pimco’s Bill Gross, the world’s bond manager, wrote Monday that at some point in 2007, the Fed will be forced to cut rates. “Don’t ask us when or how much yet,” he wrote. That will depend on housing as well as the global economy.

What’s fascinating is this time housing will be a drag, if not the precipitating factor, in a U.S. economic downturn since the banking system was deregulated in the 1980s. Indeed, since then, the Fed could simply slash rates and offset the impact of stock market crashes, as in 1987 and 2001, with a housing boom. That trick might be getting old.