Tuesday November 1, 2005 - 10:59:27 GMT
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INVESTICA Ltd - www.investica.co.uk
What to expect from the Fed
The US data had a firm bias and the dollar strengthened to highs close to 1.1970 on Monday before consolidating in New York and the US currency was close to 1.20 in early Europe on Tuesday.
The US personal income reading was much stronger than expected at 1.7% for September, supported by hurricane compensation payments, while spending rose a modest 0.5%. The Chicago PMI index strengthened to 62.9 in October from 60.5 in September with a robust advance in the orders component, although the employment index remained subdued.
As far as inflation is concerned, there was a 0.9% headline increase in the PCE inflation indicator in the personal spending data while the core increase of 0.2% gave a 2.0% annual increase which is towards the top of the Fed's comfort zone, although the rate has not moved far from 2.0% over the past few months. The prices component in the Chicago PMI index was strong, reinforcing expectations that the Fed will continue to tighten monetary policy.
There is a very high probability that the Fed will increase interest rates by 0.25% on Tuesday, taking the Fed funds rate to 4.0%. The statement will be very important and the most likely outcome is that the Fed will point to further rate increases. The dollar will be very vulnerable if the Fed hints strongly that rates are close to peaking, but this appears unlikely at this stage. There is, however a risk that the statement will introduce a greater note of uncertainty given that interest rates are now much closer to a neutral rate. It is also the case that the dollar has factored in further rate increases which will limit the scope for fresh dollar buying.
The Euro-zone PMI index edged stronger to 52.7 in October, but the immediate impact will be limited. The ECB will take a tough stance on inflation, but the Euro will be vulnerable later this week if the ECB appears unwilling to follow through the tough rhetoric and unwilling to increase interest rates.
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