Will the Fed follow Canada to reduction the interest rate below market expectation?

From Kathy Lien:

The Bank of Canada cut interest rates by 25bp to 2.25%. This move was smaller than the market expected but still represents 75bp of easing since the beginning of the month.

With the Federal Reserve set to reduce interest rates next week, Canada’s explanation for the smaller could shed some light on what the Fed may be thinking.

According to the BoC statement, Canada opted for only a 25bp rate cut for 3 reasons:


1. They have already cut interest rates aggressively this month
2. Even though they believe further easing will be necessary, they want to save their ammunition for the coming months when times will get tough
3. The recent weakness of the Canadian dollar has offset the drop in commodity prices and softer global demand

Going into the Federal Reserve’s monetary policy meeting on October 29, the market has priced in a 68 percent change of a 50bp rate cut and a 32 percent chance of a 25bp cut. However like Canada, the Fed has already cut interest rates aggressively this month and it may serve them well to be conservative with monetary easing now to leave themselves room for further easing later. With the massive amount of liquidity and fiscal stimulus that has already been announced, it may not be necessary for the Fed to go all in right now. The US economy will continue to weaken and more rate cuts beyond the move next week will be necessary.

How does Canada differ from the US?

If you caught my report on GFT Forex on Monday, I actually laid out the reasons why Canada could cut by 25bp instead of 50bp. The main reason was the improvement in Canadian economic data. The latest reports from the labor market and the manufacturing sector (IVEY PMI) was strong, reducing the BoC’s urgency to show all of their cards.

The US economy on the other hand is in worse shape. Nearly all economic data from the manufacturing sector to the labor market confirms the weakness of the US economy. Therefore from an economic standpoint, the Fed is dealing with a deeper slowdown than Canada. A 50bp rate cut is still possible if they choose to be proactive.

Related Posts :

1. US stocks opened lower, Canada tumbled 3%, Bank of Canada cuts key rate by 25bp
2. Nouriel Roubini: How to prevent contagion effects of the financial crisis in Hungary
3. $365 bln of Lehman CDS is going to be settled tomorrow
4. Iceland receives $6 bln rescue package

Sources :

Kathy Lien: Will the Fed Follow in Canada’s Footsteps?, October 21, 2008

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