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January 30, 2007
Rate hike in '07 more likely than a rate cut?
The fed funds probability charts at the Cleveland Fed now indicate that a rate hike is more likely than a rate cut in May. The market is still predicting that the Fed will keep the funds target rate at 5.25% with near certainty at the next two meetings. It is less certain about May, but if you predict movement either way, you're still facing pretty long odds.
It's a quantitatively small shift, but represents a growing sentiment out there that those rate cuts that a lot of folks were counting on in 2007 may not materialize. It's a turnaround from early December when speculation of a rate cut at its height. It was to the point that I couldn't ignore it but I was really torn. Here's what I said on December 7:
The part of me that wants to give a prediction that is right is turning to the view that there will be at least one rate cut in 2007.
The Cassandra in me is having a tough time with that.
Thank goodness for my inner Cassandra for keeping me from jumping all the way on that bandwagon.
So will we get a clue from the statement tomorrow as to which way things will break? Possibly. As Reuters reports:
Economists polled by Reuters forecast the economy grew at a 3 percent annual rate in the fourth quarter, rising from the 2 percent growth pace of the previous quarter.
Tomorrow we will know. And a statement from the Fed highlighting prospects for this pace of growth for 2007 will be interpreted as a sign of higher rates to come. But the price of oil remains a wild card. Low oil prices could keep the Fed content to remain where they are. The funds rate could stay at 5.25% all year as inflation pressure continues to abate and real GDP hits the sweet spot of 3% growth.
I believe that would be called a soft landing.
While it may be a bit premature to be calling a soft landing already, it's not too early to start establishing some criteria. What will you call it if real GDP growth is around 3% for the next two or three quarters while core PCE inflation drops below 2% and job growth averages between 125K and 150K per month? Are those appropriate criteria?
Let's see what tomorrow (Fed and GDP) and Friday (employment report) brings.
UPDATE: In related news, Bill Conerly looks at the data on housing vacancies and cannot dismiss that the possibility of recession still hangs over our heads. Calculated Risk worries about a nationwide fall in home prices this year, but gives Bernanke credit where credit is due.
Posted by William Polley at January 30, 2007 03:26 PM
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