Fed Funds Rate Discussion

Updated: November 6, 2008

.75 MOVING INTO PICTURE. Yesterday we talked about the difference between the November and January meeting outcomes. In November the probablities were favoring a cut to .5% while January was favoring staying at 1%. We thought this might be indicating short-term pessimism and longer-term optimism, especially with the end of the election. But yeseterday the Dow lost 500 points and it is down another 320 points as I write this. So, the futures markets are responding.

Looking at the charts below, the November and January probablities are starting to come together. For November a drop to .75% has now become the most likely probability followed by a cut to .5%. Lonter term optimism seems to be fading as the probability of staying at 1% in January is dropping while a cut to .75% or .5% is growing. At the moment, it looks like the market seems to be trying to come together around .75%. The Fed does not want to drop rates under 1% if necessary but if it has to will cut as little as possible. If economic conditions continue to worsen, then a cut to .5% is not out the question.

The Fed Funds Rate is a key indicator in determing the savings account rates, money markets rates, and CD rates that banks will pay. If the Fed funds rate goes down, banks usually lower their rates while the opposite is true if the Fed raises rates. While this is generally true we have not seen as strong a correlation lately. I analyzed rate changes over the last year and found that bank savings rates were much less sensitive to Fed Funds rate changes than would be expected. Up until now, rates on savings accounts and cds have held up relatively well but we've seen some significant drops in the last 48 hours. I'm going to provide more info on this shortly.