Could Fed rate hit zero?

    Just a day after the Federal Reserve dropped its key short-term interest rate to 1 percent — matching the generational low reached in 2003-04 — the betting is intensifying on another cut.

    Trading in futures contracts on the federal funds rate, the Fed's benchmark, implies a 51.4 percent probability that the central bank will slash the rate to .5 percent on or before its next meeting Dec. 16, according to Bloomberg News data.

    On Wednesday, the probability of a cut to .5 percent was 32 percent.

    At a minimum, the futures market expects the Fed to take its rate down to .75 percent on Dec. 16.

    Rate expectations might be playing off the government's report Thursday that the economy shrank at an annualized rate of .3 percent in the third quarter. Although analysts figured the economy had contracted in the period, the details were ugly — particularly the 3.1 percent decline in real consumer spending, the biggest drop since the recession that began in 1980.

    There are psychological reasons why the Fed would prefer not to cut its rate below 1 percent. The closer the Fed gets to zero, the more likely that investors will worry the U.S. economy is facing a long period of misery on par with what Japan faced after real estate crashed in the early 1990s.

    The Bank of Japan had to maintain its benchmark interest rate at or near zero for most of the 1999-2006 period, before policymakers felt comfortable that the economy was in a sustainable recovery.

    The wording of the Fed's statement Wednesday suggested that "they may (cut) again if necessary but are probably hoping that they will not have to take the zero-option on rates," said Christopher Rupkey, economist at Bank of Tokyo-Mitsubishi in New York.

    Others see more cuts as inevitable. "I think the Fed is going lower," said Tom Higgins, chief economist at investment company Payden & Rygel in Los Angeles. "Zero is the floor."

    Given the severity of the credit crunch and what that has wrought in the economy, he said, the Fed's attitude can only be, "Why not throw everything at it?"

    News In Photos

      Loading ...