Fed to Lower Policy Rate to 1% and Retain Easing Bias

Daily Forex Fundamentals | Written by RBC Financial Group | Oct 18 08 08:15 GMT |

We still expect the Fed to lower the Funds rate by another 50 basis points before the year's out with the odds favouring the move at the October 29 meeting. Economic data have been weaker-than-expected and risk a sharper downturn in Q3 and Q4 than in our baseline forecast. More worrying is the lack of traction in financial markets from the spate of policy actions with equity markets still preparing for the worst while the 3-month Libor rate is lower but remains relatively elevated. Yesterday's Beige Book provided no sign that any region of the US economy is seeing an improvement in conditions. While we believe the aggressive policy actions will eventually boost investor and consumer confidence and allay uncertainty in financial markets thereby reducing the cost of funds for financial institutions and ultimately credit spreads, the Fed will continue to keep the financial system flush with cash and interest rates extremely accommodative until a decisive turn is evident. This is unlikely to occur quickly and we maintain the view that the economy will only start to revive in late 2009. As long as the downside risks to economic growth remain paramount, the Fed will maintain a bias toward additional monetary policy stimulus which means that they may feel the need to continue easing in 2009 as a supplement to liquidity injections and targeted market operations. Our consensus view is that the 1% funds rate plus narrowing credit spreads will be sufficient to avoid a protracted economic recession although given the depth of the negative sentiment, we cannot rule out additional interest rate cuts. We expect the Fed to hold the policy rate at 1% throughout 2009 and forecast only a modest increase in term rates over the year ahead. This is a change from our previous forecast that the Fed would be in a position to increase the policy rate before the end of next year. RBC Financial Group http://www.rbc.com The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.