Tuesday, September 16, 2008

Fed Might Cut Rates? -- Fed Funds Futures Now Price in Rate Cut

The two curves below show the implied Fed Funds rate from the futures market from June 18th and Sept. 15. Stunning. The rate is now at 2.00%, but with the pressure that financials have put on the system, most hope that they stay pat, but another 25 basis point cut is being priced in with about 32% chance today, and an 88% chance of 25 basis point cut in November. Rick Santelli on Friday actually noted that from the trading floor in Chicago, traders had already begun to price the change in sentiment in as he noticed a cut was now being implied...and the VIX volatility index ( the fear index) broke through 30 again after this weekend's events.
Unbelievable stuff. But when two Wall Street icons go down, it makes sense why sentiment has changed. Most knew Lehman was going to fall due to the amount of leverage they had and the amount of level 3 assets this leverage represented, but since Merrill effectively got taken out, the domino theory was now in play. Back in the Cold War, the USSR and US fought small "theater wars" in S.E. Asia, Afghanistan, etc. US foreign policy believed it was necessary to fight Russia because of what was then thought of as the Domino theory. The Fed is now playing the same part in the current financial crisis.

Net net, Bear Stearns was "supposed" to be the only one, and the Fed's actions, vis-a-vis JP Morgan, was supposed to be the end of the credit crisis. Guess again. Whether it's the space shuttle, or financial systems, when complicated, well organized and interconnected systems fail, they fail catastrophically.