Tuesday, May 20, 2008

Fed Rate Cut History And Future

Can the Fed rate cut history show us the future for Fed rate cuts? I always knew that for the most part we have been able to fairly closely determine whether or not the Fed was going to cut the funds rate--and if so even by how much--but this morning I learned something new that I wanted to share. Before, I always looked at Fed fund futures to weigh the chances of a rate cut or increase, and while these future contracts tend to give us a pretty solid estimate, they have historically overestimated the Fed rate cuts, according to Ed Nosal, economic advisor at the Federal Reserve Bank of Cleveland. So how else can you accurately determine whether a rate cut is coming or not?

Elliot Wave International is one of the largest forecasting firms in the world, and they think they can predict to a T when a Fed funds interest rate change is coming and how much it will be for. They don’t look at the Fed fund futures, though; they look at the 3-month T-Bill yield. They put together a chart that you can see below, which shows just how accurate this method is:

Fed rate cuts graph

"And forecasting fed rate cuts isn’t all it's cracked up to be, or at least it doesn’t appear to warrant the countless hours of discussion devoted to it on financial television. As we’ve discussed numerous times in our newsletters, the Fed follows the market, not leads it. This quasi-government entity simply validates what the freely traded Treasury market has already done. The above picture should be familiar to long-time subscribers and illustrates our point about the juxtaposition between the Fed and the freely traded T-bill market. With the current gap between the U.S. 90-day T-bill rate and Fed Funds at a wide 112 basis points, the Fed’s rate cutting is not over," Steve Hochberg, Elliot Wave International's chief analyst, wrote Jan. 22 in Elliot Wave’s Short Term Update.

So if you are trying to figure out what the Fed is going to do about interest rates at their next meeting, now you have a new crystal ball to look at. As for what is going to happen at the next Fed meeting, almost everyone believes the Fed will stand pat on the fed funds interest rates, including Donald Kohn, vice chairman of the Fed.

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