This week's rate cut

Financial markets are expecting a rate cut this week and the Federal Reserve is likely to give them one. For the Fed not to do so would probably result in the kind of added turmoil that they are specifically trying to avoid and, if the September half-point cut is any indication, Ben Bernanke will be accommodating rather than provocative.

Fed funds futures contracts indicate that a quarter-point cut is the most likely outcome for this week's meeting, ominously scheduled for Halloween. The phrase "a trick-or-treat from the Fed" is already being heard and will surely continue to be uttered until 11:15 AM PST on Wednesday morning when the policy action is announced.

Chart courtesy of the Federal Reserve Bank of Cleveland

By January of 2008, short-term rates are expected to be at about 4.25 percent, implying another quarter-point cut at the December FOMC meeting.

I continue to believe that the Bernanke Fed set a dangerous precedent when they made the surprise half-point cut in September. Last week's stock market action had the feel of equity investors expecting the Fed to move this week when economic indicators - jobs, growth, and inflation - really don't indicate that one is necessary. One could argue that higher commodity prices imply that, if any move were being contemplated, it would be a rate increase aimed at heading off higher inflation.

Keep in mind that while housing is clearly suffering, and perhaps set to pick up steam with the wave of foreclosures now coming onto the resale market, broad equity markets are still up for the year - the Dow has gained 10.8 percent, the Nasdaq has risen 16.1 percent, and the S&P500 is up 8.2 percent.

Additional rate cuts are increasingly being viewed as either bold preemptive moves to mitigate the effects of the credit market turmoil on the broader economy or acceding to the wishes of Wall Street firms that will always opt for lower interest rates if given the choice.

Sometimes it's hard to tell the difference between the former and the latter.

This post is an excerpt from the most recent Weekend Update at Iacono Research. The outlook for short-term interest rates is just one of many topics that are covered each and every week, along with commodities, related equities, and foreign currencies.

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