Another Steady Rate Decision
On August 5, 2008, the Federal Open Market Committee (FOMC) voted to keep its target for the federal funds rate at 2%. The committee’s statement noted that tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. However, it added that upside risks to inflation are also of significant concern.
The committee’s decision did not surprise market participants, who had placed the probability of the steady rate decision at 90%, whereas only 7% of participants had expected an increase of 25 basis points at the August meeting. The likelihood of a 25-point rate increase at the September 16 meeting is slightly above 20%, while the probability that rates will again remain at 2% is just under 60%.
Following the June 25 FOMC meeting, implied yields on federal funds futures reached nearly 3.25% for August 2009. Between the June and August meetings, implied yields for August 2009 gradually fell nearly 50 basis points to just above 2.75%. After both the June and August meetings, implied yields dropped from their levels the day before the FOMC meeting.
Credit markets appear to be easing, as indicated by the spread between the 3-month LIBOR and the 3-month Treasury bill. The spread has moderated significantly since its high in August 2007, despite the spread’s increase since June. The Federal Reserve has taken further actions to improve liquidity: On July 30, it announced that it will lengthen the maturity of the Term Auction Facility and extend the Primary Dealer Credit Facility and the Term Securities Lending Facility through January 30, 2009. In the days following this announcement, the spread declined, which indicates that credit markets are improving.