Magazine article Economic Trends

Monetary Policy

Magazine article Economic Trends

Monetary Policy

Article excerpt

Markets suggest that we may be nearing the first pause after federal funds rate increases of 25 points (bp) at each of 17 consecutive FOMC meetings. After the June 28-29 meeting, the rate stood at 5.25%, which represented an increase of 425 bp from the recent low of 1% in June 2004. The current tightening cycle has lasted longer than both the 1994 and the 2000 tightening cycles.

Participants in the federal funds options market currently place a probability of roughly 70% on maintaining the 5.25% target rate at the August meeting. A 25 bp increase has around a 30% probability. On July 19, the CPI release showed that core inflation (excluding food and energy) exceeded expectations by posting a 3.6% (annualized) increase. This would ordinarily have been expected to strengthen the probability of a rate hike, but the release coincided with the Semi-annual Monetary Policy Report to Congress, in which Federal Reserve Chairman Ben Bernanke stated, "FOMC participants project that the growth in economic activity should moderate to a pace close to that of the growth of potential both this year and next. Should that moderation occur as anticipated, it should help to limit inflation pressures over time." On the whole, his statement signaled to futures market participants that a pause is more likely.

The probability of a pause at both the August and September meetings is roughly 70%; the probability of a 25 bp hike at one of these meetings is approximately 30%. …

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