Economists with TD are expecting central banks in the U.S. and Canada to cut rates further still.

In a research note, TD Economics says the efforts of various monetary and financial authorities “now seem to have some traction and have consequently begun to placate credit markets.” It observes that not only have credit spreads started to narrow, but volatility indices are lower, although funding costs “remain stubbornly high”.

TD says that it believes U.S. interest rates will go lower. “The two prevailing concerns — the economy and the credit market –are still undergoing massive transitions. Admittedly, there have been tentative signs of improvement in the credit market, but the market is nowhere near full and robust health,” it says. “As such, we are looking for the Fed to cut rates another 50 [basis points], in two consecutive 25 bps installments, leaving the fed funds rate at 0.50%.”

That’s the forecast, but TD allows that in the current environment, “all options are on the table and one must not neglect the possibility that the Fed could have to do more than what we have priced in, which raises a number of questions about the implications of a zero per cent fed funds rate. Still, we favour the odds of a 50bps floor in the fed funds rate at present.”

At the same time, TD observes that Canada’s immunity to the nasty global virus is waning. “The Bank of Canada’s revised forecasts are a good deal gloomier than in July. GDP growth is expected to be a slight 0.6% in 2008 and 2009 and it is not expected to return to potential until 2010. TD’s view is even weaker than that and there is a non-trivial downside risk to even our pessimistic outlook,” it says.

It predicts that the Bank of Canada is likely to cut rates another 50 bps at the December meeting. “This will leave the Bank’s overnight rate at 1.75%, which is a historical low. As with the U.S., the bond market implication is that we could see lower yields across the curve, while the Canadian dollar has further room to decline,” it says.