Magazine article Economic Trends

Reserve Market Rates and Discount Window Lending

Magazine article Economic Trends

Reserve Market Rates and Discount Window Lending

Article excerpt

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At its September 18 meeting, the Federal Open Market Committee (FOMC) voted to lower the target federal funds rate 50 basis points to 4.75 percent. This was the first rate reduction since the last round of rate increases ended in June 2006.

Since that meeting, participants in the Chicago Board of Trade's federal funds options market have seen it as ever more probable that the outcome of October's meeting would be to leave the funds rate at 4.75 percent. For instance, on September 19, markets were evenly split between no change and a further 25 basis point reduction at the October meeting, with just less than a 40 percent probability for each possibility. But by the beginning of October, participants actually placed a slightly higher probability on a 25 basis point cut as opposed to no rate change at the October meeting. However, a favorable employment report on October 5 reversed this, tilting the probabilities in favor of no rate change.

On October 9, the FOMC released the minutes of its September 18 meeting. In the minutes, the committee noted, "The information reviewed at the September meeting suggested that economic activity advanced at a moderate rate early in the third quarter." The minutes also discussed the "exceptionally weak" housing sector, noting "deteriorating conditions in the subprime mortgage market" and indicating that "the availability of financing to borrowers recently appeared to have been crimped even further." Meeting participants expressed concern that developments in credit markets could potentially "restrain aggregate demand in coming quarters." Participants also noted that although there had been some improvement in financial market conditions in the days prior to the September meeting, conditions "were still fragile." Committee members voted for a 50 basis point cut in the funds rate as the "most prudent course of action" to "forestall some of the adverse effects" of credit market conditions.

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The release of the minutes did have a mild impact on market participants' views of the future course of monetary policy. The minutes' release further shifted options market participants' views toward no change in policy at the October meeting, and participants currently place over a 65 percent probability on no change in policy in October. Meanwhile, the federal funds futures market indicates the possibility of a further rate cut by year's end.

During August and September, the federal funds rate exhibited marked volatility. …

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