The current 1.5% Fed funds rate isn’t long for this world. The Federal Reserve, perhaps in coordination once again with other central banks around the world, will cut interest rates, and soon.
That, at least, is the market’s view. The November ’08 Fed funds futures contract has all but priced in a 50-basis-point cut to 1%.
The announcement of a cut, whatever it is, will come as a shock to no one, given the events of late. Indeed, money supply has been rising at extraordinarily high rates in reaction to the extraordinarily dire state of affairs in finance and increasingly on the economic front. M1 money supply (the narrowest measure) surged more than 19% on a seasonally adjusted annualized basis for the three months through September 2008, the Fed reports. A year ago, M1 was up a mere 0.8% over the same time frame.
Such an aggressive creation of liquidity will be met with lower interest rates…again. But we’re coming to the end of this road, and the dangers (psychological as well as economic) are growing. It’s no longer beyond the pale to consider the possibility that the Fed will drop rates to zero, depending on how the turmoil unfolds in the coming weeks and months. What happens when Fed funds have sunk to nothing remains an open debate, but this future appears to be rushing toward us.