The Federal Reserve is expected to raise rates again at Tuesday’s meeting according to the Fed Funds Futures. Despite calls from all corners to hold off raising rates, the market is anticipating another 25 bps raise. And according to the Fed Funds Forwardation, the Fed could likely go to 4% in the first quarter of 2006.
Source: Bullandbearwise.com
Even the Fed is signaling that it will raise rates once again at Tuesday’s meeting. The Fed effective rate vs its stated target rate indicates that the Fed is already starting to price in a 25 bps tightening. The effective rate has moved up several days before the last couple of tightentings and it looks to be doing the same again.
Source: Bullandbearwise.com
However, despite the "tightening bias" by the Fed, it is adding liquidity through its open market operations. Most notably, the Fed has added liquidity through several permanent market operations in the past weeks. Even before Hurricane Katrina hit New Orleans, the Fed undertook several permanent market operations. According to most economists, these operations have a much more significant affect on liquidity than the typical day to day operations.
Source: Bullandbearwise.com
So it seems that despite talking tough on tighter monetary policy, it seems the Fed is injecting liquidity through its open market operations. The permanent market operations are typically very bullish for stock prices because the added liquidity eventually finds its way into financial assets. However, it’s unclear to me whether the permanent market operations can overcome the higher short term interest rates. Nevertheless it bears watching as the Fed seems to be taking away liquidity with one hand but adding it with the other.