The Federal Reserve will meet today faced with an important
decision that some say is the most pivotal of the year. The Federal Open Market
Committee is going to have to decide whether to abandon its belief that the
economy is on a path to a slow, uncertain recovery or begin to consider new
ways to keep the recovery from losing steam.
The recent series of weak economic reports including last
Fridayâ€™s disappointing jobs data has caused the Fed policymakers to abandon
their crusade against inflation, and shift their focus on the strong
possibility of deflation.
At this time the Fed is walking a thin line. It has to be
cautious about what signal it sends to investors today. With todayâ€™s decision,
it does not want to fuel pessimism. On the other hand, a deflationary spiral
has the potential of being devastating to the economy.
The Fed cannot afford to be late in responding to the threat
of deflation because unlike inflation, it is too hard of a problem to fix. In
the past, the Fed has demonstrated that it has the tools to fight inflation,
but a deflationary scenario is another story.
Traders should be prepared for just about anything from the
Fed today. It may decide to pass on any concrete plans to stimulate the economy
or it may renew its quantitative easing program. Experts expect, at a minimum,
the Fed will acknowledge the slowdown in the recovery and discuss steps to
revive the economy through asset buyback programs similar to what they just let
expire in March.
Another issue facing the Fed today is just how seriously its
members are taking the threat of deflation. Most experts agree that Fed
Chairman Bernanke has enough votes to alter previous policy statements since
based on previous meetings; there is only one true hawk on the FOMC. However,
there are only two members who have previously voiced their opinions on the
threat of deflation.
Based on this assessment, the Fed is likely to revert to
using a tool that it is familiar with â€“ quantitative easing â€“ rather then
introducing fresh, untested weapons. This means that if it decides on anything
at this meeting it will be another round of purchasing financial assets to hold
down long-term interest rates and increase the supply of money.
Most analysts agree the Fed is likely to renew its QE
policy, but have left open the possibility it will discuss lowering the
interest it pays on reserves that banks keep at the Fed in excess of what they
are required to, and altering the â€śextended periodâ€ť language it has been using
to describe how long short-term interest rates will remain at â€śexceptionally
As mentioned earlier, however, the key will be how the Fed
presents its plan to the investment world. The Fed has to act with clarity and
conviction and not trigger thoughts of an overreaction. If investors interpret
the FOMC decision the wrong way, a wave of pessimism could hit the marketplace,
driving equity markets sharply lower and the Dollar and Treasury instruments
This morning, investors seem to be leaning to the
pessimistic side of the equation. Risky assets are taking a hit including
currencies, equities, gold and crude oil, as traders shed positions ahead of
this afternoonâ€™s FOMC decision.
A flight to safety rally is taking place in the Forex
markets but this isnâ€™t the only reason for the strength in the Dollar.
A softer U.K.
housing report is overshadowing this afternoonâ€™s U.S. Federal Open Market
Committee announcement as falling house prices increased jitters in an already
Early in the trading session, a report from the Royal
Institution of Chartered Surveyors said July house prices turned negative for
the first time since July 2009. This report resonates other reports that showed
a rising supply of houses for sale and decreased buyer interest. The return of
a buyers market indicates the strong possibility of a softer housing market
through at least the end of the year, leading to speculation of a double-dip
Technically, after failing to follow-through to the upside
following the penetration of a major Fibonacci retracement level at 1.5967 in
two out of the last three trading session, the British Pound took out a main
swing bottom at 1.5819. This move turned the main trend down on the daily chart.
The chart pattern suggests that 1.5633 is the next likely downside target,
followed by an uptrending Gann angle at 1.5400.
Concern about a slow down in the global recovery is also
pressuring the Euro. Before the New
York session opening, the Euro is trading on its low,
threatening to turn the main trend to down on the daily chart on a move through
the last swing bottom at 1.3119.
Based on the range of 1.1876 to 1.3334, the chart indicates
that this current break could turn into something substantial if investors
decide to begin shedding risky assets. If this current break turns into a hard
correction, the daily chart indicates that 1.2605 would be the minimum downside
target. This price represents a 50% correction of the June to August rally.
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POTENTIAL PRICE RISK: HIGH to Medium- Wed --14:15 GMT-- US- Industrial Production
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