A Possible Rate Cut Next Wednesday?

The Federal Open Market Committee meets next Wednesday, and I haven't heard any speculation out there about a rate cut on the Fed Funds target from 5.25% to 5.00%. However, the daily Repo rate has been below the target for the last two weeks. Today it was 5.06%, with somebody having the nerve to bid 4.98%. I personally take this as a signal to the Fed that certain banks want short term rates lowered.

The member banks want lower rates and a normal yield curve. Inverting the curve was fine and dandy for squeezing out competition from the subprime lenders, but now big banks are getting in trouble too. They'd like to cut the rates they have to pay depositors and boost the rates they collect from borrowers. That will restore some profitabilty to their core business to offset some of what they are losing through defaults.

A Fed Funds rate cut would not be good for the dollar, although it's the higher yielding long term securities that matter the most for carry traders. If longer term yields fall (boosting the price of securities) it helps those already in carry trades, but it discourages new traders for entering into them and sucking up supply of trade gap dollars. That could lead to a falling dollar, much higher long term rates and a falling stock market.

Up until now, the Fed has been on the side of protecting the dollar and US banking profits tied to the Yen carry trade. If the Fed goes through with the rate cut next week or at the June 27/28 meeting we could be in for some dramatic changes in the rebalancing process.