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February 06, 2006

And The Funds Rate Probabilities Say: 50/50 For Five

Last week I provided a defense of monetary policies that err on the side of being overly aggressive on the inflation watch, using the 1994 rate hikes and their aftermath as a case study.  Several people  -- Jim Hamilton included -- suggested I might be guilty of a bit of cherry-picking, selectively choosing one of the episodes that worked out well when there are plenty of others that (apparently) worked out less well. 

That is fair enough and, as James points out, there will indeed be episodes where I might "regret [policy] tightening as much as it did."   But this is somewhat like regretting the purchase of fire insurance because your house didn't burn down -- we might have been better without the insurance after-the-fact, but prudent risk management suggests that betting on that outcome is not the wisest course.

But here's the rub: The policy users guide is missing a few pages in the section describing what constitutes "prudent risk management."  In my post I emphasized inflationary pressures. Jim emphasized real economic growth and, not unwisely, continues to worry about driving the spread between long- and short-term rates to levels that are disproportionately associated with economic weakness.

Jim won't be happy with this week's estimated funds rate paths:

Slide1_3

Slide2_3

Today the ten year Treasury yield closed at 4.54%.   I'm pretty sure a 50% chance of another 50 basis points on the funds rate by May is not the sort of caution Professor Hamilton is looking for.

The data:
Download Imp_pdf_slides_for_blog_020306.ppt
Download implied_pdf_march_020306.xls
Download implied_pdf_may_020306.xls

February 6, 2006 in Fed Funds Futures, Federal Reserve and Monetary Policy | Permalink

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Comments

Thanks for posting this every week. Since I've been in the 4.75% camp for some time, I guess I'm not surprised - but I thought that would be it. I'm a little surprised by the odds for May. I guess time and data will tell.

Best Regards!

Posted by: CalculatedRisk | February 06, 2006 at 11:09 PM

full speed ahead on rate raises. the options skew is off too. three month credit spreads have started to price in two more raises. I had been waiting for a few months for them to move, and the front eurodollar spread finally started to move within the past week. That may be where they stop. Doesn't the fed always go a little bit too far?

Posted by: jeff | February 07, 2006 at 03:49 PM

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