In the aftermath of the Federal Reserve's decision to hold rates at 2.00% and the U.S. Government's move to bail out struggling insurer AIG, Fed funds futures are pricing in an 80% chance of a 25 bps rate cut for the next FOMC meeting, scheduled for October 29.
In what has been an unprecedented week of bailouts and financial collapse, markets are no longer pricing in a rate hike. For the next meeting, scheduled in October, the implied probability is pricing in a 20% chance of a 50 bps rate cut.
Ashraf Laidi, chief FX strategist at CMC Markets, thinks the Federal Reserve is rewriting the rules with the bailout of AIG.
"This announcement risks further desensitizing markets at the next major intervention or buyout by the 'authorities'. While on one hand the Fed is attempting to stick to the rules of attaining price stability by not cutting interest rates, it has broken all rules of bailout and moral hazard," he wrote.
Analysts from Citigroup expect the Fed to pause on rate cuts while it focuses on stabilizing AIG.
"Post-meeting, markets have moved to price in a 50% chance of a 25bps cut at the next meeting but are looking for unchanged rates over 12 months," they wrote. "Barring downside economic surprises, it appears likely that the Fed will now remain on hold for an extended period. The effect of the AIG rescue will likely be able to compensate for the market's disappointment with Fed rate inaction."
Looking ahead to the year-end meeting set for December 16, the implied probability for a 50 bps rate cut has grown to 36.6%, up from 16.8% a day ago.
For the Federal Reserve meeting scheduled for January 28, markets are now pricing in a 56.7% probability of a 25 bps rate cut and a 34.1% chance of a 50 bps cut.
By Steve Stecyk and edited by Sarah Sussman
©CEP News Ltd. 2008