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Another Federal Reserve Rate Cut Decision at Trader’s Narrative

Today we’ll be keying off only one market tell: the scheduled Federal Reserve rate cut decision.

I’ve been following a simple model of the Fed’s actions: approximation of the 90 day US government T-Bond yield. At yesterday’s close, the 3 month US Treasury Bond’s yield was 2.280% and in overnight trading they were a bit lower at 2.20% (last time I checked).

Here’s a recent graph comparing it with the Fed rate (in blue):

fed rate decision jan 30 2008

If only they’d listened to me when I suggested they cut, way back in the summer of 2007! ;-)

The Fed is now way behind the curve and in a desperate (some say futile), last ditch effort to forestall a recession in the US economy. I know this sounds crazy but they would have to cut 125 basis points to bring the Fed target rate in line with the bond market - see above graph.

The odds are that we will get a generous rate cut. But probably not that generous. According to Federal Fund futures, we have more than a 70% chance of a 50 basis point cut and about a 30% chance of a quarter point cut. But really, no one knows what the Fed will decide.

All I know is at 2:14 pm today, the futures will go nuts. Since the market is clearly expecting (and needs atleast) a 50 basis point cut, anything less will be a major disappointment. If we get anything more, we could be riding a rocket. The market is clearly in a very oversold condition and a catalyst like an unexpectedly larger rate cut would be all it needs to recover. If we do get exactly 50 basis points, we could flail around and end the day unchanged for the most part.

In any case, the first directional jab is usually a head fake, or has been in the past. So unless you really really have to don’t trade around the decision time.

If you do, just know the risks. Including the risk of losing internet connectivity, losing power, etc. Believe me, you don’t want to be stuck in a position that can move against you mercilessly unless you have planned for every contingency.

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7 Responses to “Another Federal Reserve Rate Cut Decision”  

  1. 1 Ben Bittrolff

    Make sure you’re sitting down before you fire up these charts.
    Really Scary Fed Charts, Why Bernanke Will Cut Furiously


  2. 2 Johan

    If the problem only was to lower the interest rate a lot to make the market go up… what a wonderful world it would have been. I don’t agree that a, let’s say, 100 point cut would mean a bullish market. Not in the short nor long-run.

  3. 3 Grant

    Why exactly does the Fed need to keep the Fed target rate in line with treasury rates, Babak?

  4. 4 Babak

    Grant, everything has a price. The interest rate is the “price” of money itself. No matter how well informed a committee may be, they can never rival the price discovery mechanism of a free and open market. This is why the bond market is the best place for the discovery of the true price of money - or the interest rate. The Fed does its best to mimic the freely set rate in order to match supply and demand.

  5. 5 Grant

    Okay, regarding matching supply and demand: I guess I’m trying to understand what the overnight lending rate between banks has to do with the rate for t-bills exactly? To an uneducated eye like mine, they seem unrelated.

  6. 6 Babak

    Grant, there are many financial “products” and each has its own “price”. Overnight lending between banks is different than a 90 T-Bill for obvious reasons. The FOMC’s rate influences overnight lending rates and filters through the financial system.

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