Wall Street bets on more Fed cuts

NEW YORK (CNNMoney.com) -- Even though the Federal Reserve slashed its key federal funds rate by three-quarters of a percentage point in an emergency meeting Tuesday, Wall Street is still betting that the central bank will lower rates again next week.

The Fed will hold a two-day meeting that wraps up on Jan. 30. And according to futures listed on the Chicago Board of Trade, investors are pricing in a 100 percent chance of at least another half-point cut, to 3 percent, and a 48 percent likelihood of another 75 basis point cut, to 2.75 percent. (There are 100 basis points in a full percentage point.)

"There is a legitimate chance of another cut next week. The Fed wants to stay in front of things and at this stage, they'd rather err on the side of having rates be too easy than too restrictive," said Jack Ablin, chief investment officer with Harris Private Bank.

"The Fed doesn't want to be blamed for making a downturn worse than it already is," Ablin added.

Economists from Merrill Lynch and Goldman Sachs both are predicting a half-point rate cut next week and Merrill's economists went as far to suggest that the Fed may need to eventually bring the federal funds rate back down to 1 percent. The federal funds rate was last that low in May 2004.

But some market observers said that another rate cut is not guaranteed next week and that the Fed now needs to be more cautious.

"There are already rumors that the Fed may cut more next week but at this point, I would think that they are going to stand pat," said Oscar Gonzalez, economist with John Hancock Financial Services in Boston.

Gonzalez argues that since the Fed took such drastic action on Tuesday, it may not want to make another move so soon but would rather wait and see what economic data for January and February looks like before cutting rates again.

He thinks the Fed could ultimately lower the fed funds rate to between 2.5 percent and 3 percent if the economy continues to weaken.

Cuts are coming, but don't hold your breath. Ed Yardeni, president of Yardeni Research, an independent market research firm, agreed. He sees more rate cuts ahead...but not next week.

"The Fed probably won't do anything next week. They are going to take a break now and see how things unfold," he said.

But Yardeni added that if the global financial markets continue to plunge in the next few weeks, the Fed may be forced to do another emergency rate cut before it meets again on March 18.

Proceed with caution. John Norris, managing director with Oakworth Capital Bank, a private bank in Birmingham, Ala., said he thinks the Fed might cut rates again next week but he is hopeful that the Fed doesn't go much lower.

Norris said that a federal funds rate of 3 percent would be low enough to stimulate growth again without risking too much in the way of inflation. But he is concerned the Fed may cut rates too much.

Some economists have argued that the Fed lowered rates too aggressively during the 2001 recession - the federal funds rate eventually bottomed out at 1 percent - and that those historically low rates helped encourage the type of reckless subprime lending that is the root of the current economic crisis.

"I hope the Fed is not that foolish to jeopardize long-term financial health just for short-term stimulus. So if they cut rates again next week, hopefully that will be it for a very long time," Norris said.