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Wednesday January 30, 2008 - 01:23:49 GMT

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Forex Research - How Much Will the Fed Cut at Its January Meeting: 25bp or 50bp?

Tuesday, 29 January 2008 22:04:12 GMT

Written by Kathy Lien, Chief Strategist

• Euro Stalls Ahead of Federal Reserve Interest Rate Decision
• British Pound Headed for a Test of 2.0

How Much Will the Fed Cut at Its January Meeting: 25bp or 50bp?
All eyes are locked on the Federal Reserve’s monetary policy decision tomorrow afternoon. The price action of the US dollar has been mixed since the beginning of the week indicating that traders are not ruling out any surprises. Fed fund futures are pricing in a 72 percent chance of a 50bp rate cut and a 28 percent chance of a more conservative 25bp cut. Of the 86 economists polled by Bloomberg, 49 expect a 50bp cut, 23 expect a 25bp cut, while 13 expect rates to be left unchanged (the one remaining economist believes that there will be a 75bp rate cut). DailyFX readers actually actually favor a 25bp rate cut over a 50bp cut and interestingly enough, the votes between 50bp and nothing at all are very close. In other words, the consensus across the markets is not very strong. We believe that the Fed will nod to the markets once again and cut by 50bp. Shortly after the emergency rate cut, there was a decent chance that the Fed could make two back to back 75bp rate cuts. But since then, traders have become far more realistic by realizing that the world has not come to an end and stocks have stabilized. As a result, rate cut expectations have eased significantly. Since the emergency rate cut last week, stocks have rebounded 800 points, durable goods increased strongly in the month of December, gold prices have hit record highs while oil prices regained strength. The housing market still remains vulnerable with house prices as measured by the Case Shiller index falling to the lowest level in 7 years. The choice between a 25bp or 50bp rate cut is really the choice between being “at the curve” or “ahead of it.” By the end of this year, we expect interest rates to come down to at least 2.50 percent, which is 100bp from current levels. The Fed can get half of that easing out of the way on Wednesday and enjoy the benefits of easy monetary policy throughout the second half of the year or they could cut by only 25bp and work for each tenth of a percentage point increase in GDP. Either way, there is a slim chance of the FOMC rate decision being dollar bullish because tomorrow’s rate cut will certainly not be their last. Before the rate decision, there could be some action with the ADP employment change and the advance release of fourth quarter GDP.

Euro Stalls Ahead of Federal Reserve Interest Rate Decision
The Euro has stalled near the top of its weeklong trading range ahead of the Federal Reserve’s interest rate decision. The Eurozone current account, French consumer confidence and housing starts were released today and all of the numbers should have been Euro bearish. Yet the currency is unchanged against the dollar thanks to the ECB’s stubbornly hawkish monetary policy stance. ECB member Orphanides continues to be optimistic about the Eurozone’s economy when he said today that he is not worried about a slowdown in growth. This may be in reaction to the comments from European Union leader Junker who plans on cutting the region’s growth forecasts. German retail sales and Eurozone retail PMI are due for release tomorrow. Spending is expected to improve thanks to a strong labor market. Meanwhile, the Swiss franc is weaker across the board following a narrower than expected trade surplus last month and a drop in the UBS Consumption Indicator.

Visit the Euro Currency Room for resources dedicated specifically to the Euro.

British Pound Headed for a Test of 2.0
Despite weaker economic data, the British pound appears to be headed for a test of 2.0. According to the CBI Distributive Trades survey, consumer spending slowed in the month of January but that did not lead to a sustained sell-off in the British pound. The main reason is because it is not significant enough to convince the Bank of England to lower interest rates again next month. According to a special technical analysis report that we published last week, after falling nearly 2,000 pips from the November high, the current rally that is underway could take the British pound up to at least 2.01. There are a few pieces of housing market data due for release tomorrow. Given that housing is one of the most vulnerable aspects of the UK economy, the data is not expected to be pound bullish.

Visit the British Pound Currency Room for resources dedicated specifically to the Euro. 

Canadian, Australian and New Zealand Dollars Rally, Will the Reserve Bank of Australia Need to Raise Rates?
The Canadian, Australian and New Zealand dollars continued to extend their gains despite a retracement in gold prices and a marginal rise in oil prices. Stronger Canadian business orders have contributed to the loonie’s strength; upside surprises in Canadian economic data are rare occurrences these days. There was an interesting article in the Australian this week, which is the country’s most popular newspaper calling for a 50bp rate hike by the central bank to bring prices under control. If the RBA raised rates at their next meeting, they would be the only major central bank to be doing so, which would be a big positive for the Australian dollar. New Zealand on the other hand reported much weaker than expected building permits but that had a minimal impact on the New Zealand dollar.

Tell us what you think on the Canadian dollar Forum.

Carry Trades Rally Unimpressive Despite another 96 Point Rally in the Dow
The Japanese Yen crosses are higher today on the heels of another 96 point rally in the Dow. Given the size of the move in equities over the past 2 trading days, the rally in carry trades are unimpressive. We continue to believe that the correlation between equities and currencies are breaking down because the people who are buying stocks are not the same people who are buying carry trades. Also, there may not be new money flowing across the financial markets. Many of these dollars, Euros, and Yen may just be parked on the sidelines in the local currencies waiting for the next best opportunity. Japanese economic data was stronger than expected with the unemployment rate holding steady and overall household spending beating expectations. Industrial production is up next.

Visit the Japanese Yen Currency Room for resources dedicated specifically to the Euro.




By Kathy Lien, Chief Strategist of
Contact Kathy Lien about this article at [email protected]


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