Future Interest Rates - How Would You Bet?

From Bloomberg:

. . . . In the options market where the savviest investors take apart conventional wisdom, the Federal Reserve is facing growing pressure to consider raising interest rates as soon as December.

Options on Federal Fund futures at the Chicago Board of Trade indicate a 41 percent chance the central bank will lift its target rate for overnight loans between banks to 5.5 percent from the current 5.25 percent, according to data compiled by Bloomberg. A month ago, they showed no expectations for an increase.

While the economy expanded at the slowest pace in more than four years in the first quarter, inflation remains at the top of the Fed's comfort zone, business activity has rebounded, the jobless rate is near the lowest in six years and stock indexes are setting record highs. Just three months ago, options traders speculated the weakest housing market in 16 years would force the central bank to cut interest rates to 4.5 percent by January.

. . . . The chance of at least one cut in the overnight lending rate between banks has fallen to 29 percent from 83 percent since the start of May, options prices show.

Federal Reserve policy makers ``have started to tell us in pretty consistent language they're not satisfied at being at the upper band'' of their inflation target. . . .

. . . . Options more accurately reflect changes in monetary policy than futures contracts, the most widely used barometer, because they include the widest array of wagers, according studies by the Federal Reserve Bank of Cleveland in 2005 and the Federal Reserve Bank of St. Louis in 2006.

. . . .The CBOT first listed the options in 2003 and began offering contracts in July that allow bets on the Fed's target rate. The so-called binary options pay $1,000 if an investor bets correctly on the Fed's interest-rate decision at regularly scheduled meetings. Investors get nothing if they bet wrong.

. . . . Economists at Barclays Capital Inc., JPMorgan Chase Inc. and Bear Stearns Cos. have been predicting higher rates since the Fed left its target unchanged last August. They forecast at least one increase this year and another by the first quarter of 2008. . . . .

. . . . ``We are definitely seeing more and more people moving away from the Goldman and Merrill argument that the Fed is going to cut multiple times.''

What is the real concern, inflation or the housing market? That determines how you vote. My vote is for a rate increase.