Magazine article Economic Trends

Money and Financial Markets

Magazine article Economic Trends

Money and Financial Markets

Article excerpt

Options on federal funds futures have traded on the Chicago Board of Trade since March 2003. Unlike the federal funds futures market, the structure of this option market can furnish an estimate of the distribution of expected policy changes. On June 24, participants placed a high probability on a cut at the meeting on the following day, with the probability of a 50 bp cut exceeding that of a 25 bp cut.

Movements in the yield curve since May 6 also foreshadowed an easing at the June 25 meeting. Yields declined roughly 25 bp to 40 bp across the spectrum of maturities. After the rate cut of June 25, the yield curve moved upward 10 bp to 16 bp, with the two-year yield increasing the most.

Under a policy in effect since January 9, 2003, Federal Reserve Banks extend short-term credit to qualified institutions at the primary credit rate, currently 100 bp above the intended federal funds rate. This credit is extended with "no questions asked," unlike the previous regime, which rationed credit at the discount window. It was hoped that such a change would encourage use of the discount window and contain upward movements in the federal funds rate. However, as has been true since the early 1990s, use of the discount window remains low. In fact, since the introduction of the new regime, outstanding primary credit has averaged only $12 million. From January 1990 to the end of 2002, adjustment credit borrowing averaged $113 million. So far, upward movements in the federal funds rate have been contained. Since the regime change, the federal funds rate reached the primary credit rate on only one clay, May 14.

Short-term interest rates continue their strong downward trend, moving together with the federal funds rate during this period of easing. The yield curve remains relatively flat at the short end, with three-month, six-month, and one-year Treasury bill rates within 10 bp of one another. Nonetheless, the spread has increased in the last few weeks, which may indicate expectations of a round of policy tightening in the coming year.

Interest rates on conventional mortgages have declined nearly 70 bp since late March. Yields on long-term government securities declined more than 50 bp during the same period. Low mortgage rates contributed to a 6.1% increase in housing starts between April and May.

The spread between the 90-day commercial rate and the three-month Treasury bill rate remains low, probably because only higher-quality issuers remain in the market. …

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