The funds rate matters less, but there are three reasons why it still matters. The Fed will repeat its themes from Oct. 8 and might add a line to reflect the idea of keeping the funds rate low for a time; that would help steepen the yield curve -- a favorable outcome.

The real story regarding the Federal Reserve is its various liquidity operations; the federal funds rate is second fiddle. The federal funds rate nonetheless remains a powerful tool, and it would be a mistake to dismiss its importance for two reasons.

For one, cuts in the federal funds rate are not done by fiat but by altering the amount of money in the financial system. In other words, in order to cut the funds rate, the Federal Reserve must inject additional reserves into the banking system --an announcement is just an announcement. Second, large amounts of household and business debts are tied to the prime rate, which is tied to the funds rate. (Mind you, these debts are tied to the target funds rate, not the rate the funds rate trades at in the inter-bank market each day. That is why an official cut in rates is significantly more important than a decline in rates in the inter-bank market.)

To add a third reason, cuts in the funds rate make news on Main Street in ways the CPFF, the TAF, the MMIFF, the TSLF, etc., can't.

The market is priced fully for a 50-basis-point cut. Whether it is priced for more is debatable; fed funds futures are trading at 0.88%, but that rate probably reflects an expectation that the funds rate will trade below the 1% target, just as it has the past two weeks, when it traded at an average of 0.79%, well below the Fed's 1.5% target. More likely, the market is placing very low odds on a 75-basis-point cut. A 75-basis-point cut would help steepen the yield curve, and that is one basis for choosing the more aggressive route.

The policy statement is expected to contain acknowledgments made on Oct. 8, when the Fed delivered a "surprise" 50-basis-point cut alongside other central banks, including the Bank of England and the European Central Bank. In the Oct. 8 statement, the Fed said that "the pace of economic activity has slowed markedly," a characterization that is likely to be maintained.

In reference to financial conditions, the Fed said that "the intensification of financial market turmoil is likely to exert additional restraint on spending," a statement that also rings true today. On inflation, it is important for the Fed to align itself with the market by giving more weight to deflationary tendencies that are now so abundant. The market would be somewhat forgiving of any failure by the Fed to acknowledge the downside risks to inflation, mainly because the Fed's actions mean far more than its words these days, but it would still be better to see the Fed recognize the downside risks to inflation, given the virulent impact that deflation can have.

If there's something new that would be expected today, it would be some form of indication that rates will be kept low for long, although the use of the phrase "considerable period" might be shunned, given the criticism that Alan Greenspan has seen as a result of making the same commitment in the last round of deep interest rate cuts. Indications that the Fed will keep the funds rate low for longer would benefit the short-end of the yield curve and help steepen the yield curve, which would be a favorable development for the banking system.

The real drama remains with the Federal Reserve's liquidity operations, which took on a new dimension on Monday with the launch of the Fed's commercial paper funding facility. In addition, the paying of interest on bank reserves has enabled the Fed to expand its balance sheet without the expansion having an impact on the federal funds rate, rendering the targeting of the funds rate somewhat less important than before. (This is not because the funds rate is irrelevant, for the reasons I described earlier, but because the Federal Reserve's efforts to revive the economy and the financial system are depending increasingly on the expansion of the Fed's balance sheet.)

Adding to the drama that is outside the funds rate is the imminent deployment of TARP funds, with $125 billion headed to the "club" of nine major banks any day now, an amount with the potential to provide up to $1.25 trillion of bank credit. Much more is one the way, and that is why Libor looks likely to continue its fall and why November is looking far better than October for the world's financial markets.
Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of the revised investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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