Fed Funds Rate Down to 3% in 2008?
According to Larry Kudlow writing in his most recent column:
"The Fed also must undo the inverted Treasury yield curve whereby the 4.5% Fed Funds rate remains well above the 4% 10-year Treasury rate. This situation has prevailed for 18 months (see shaded area in chart above); unless it's fixed immediately, it represents an illiquidity threat that increases the odds of recession. A 3-month Treasury bill around 3% is pointing the way for the fed funds rate."
Over the last half century, the Fed Funds rate has been below the 10-year Treasury yield by an average of 0.87%. Assuming that the 10-year Treasury rate remains at about 4%, that would mean that the Fed Funds target rate would have to get down to somewhere between 3% and 3.25% to restore the historical relationship between the two benchmark interest rates (see chart above). In that case, a 50 basis point rate cut in the target Fed Funds rate today to 4% would be a good start, and additional rate cuts next year could be expected.
Interestingly, the Fed Funds futures contracts for December 2008 are predicting a Fed Funds rate of about 3.4% a year from now.