My Diary 426 --- Will the Fed cut help and How much?

Will the Fed cut help and How much?

The unprecedented development of overnight market seems once again kidnapped FOMC again. This is also the first time over the past few meetings that FOMC decision look uncertain.

The futures market is pricing a 68% chance that the Fed will cut the funds rate tonight and the short end yield curve is in negative spread to FFTR. In light of the extreme stress in the financial markets, a rate cut is possible, especially if policymakers believe it will stabilize market psychology.

But I think a rate cut does little to help ease the Wall Street fire, because the ongoing market crisis is not about the price of credit, but rather the availability of credit. Right now, financial institutions are fearful of further bankruptcies and counterparty risk. A lower fed funds rate does not directly address this.

I still think the Fed would prefer to use TSLF to enhance liquidity provisions and to broader the definition of collateral at the discount window to include equities and high yield securities-as a way to improve market liquidity. 

If the Fed capitulates to the markets' demands for a rate cut, I think the Fed would be more likely to move 50 bps instead of 25 bps. As other wise, the market will ask for more…SO do not rule out the possibility of 1% Fed Fund rate at this stage.

As Greenspan said yesterday, he expected more to come and bigger FIs to fall….Stay Tune!!!