Fed Vote Split To Get Attention
After the intra meeting cut of 75bps on the Fed Funds rate last week, the US Fed is likely to deliver its second successive rate cut for 2008 just 7 days later. So far, the US Fed has cut the Fed Funds Rate by 175 bps from a high of 5.25% in Aug-2007. In light of this the extent of today's rate cut however is debatable, given that a 75bps rate cut was delivered just last week and policy rates usually take 6-9 months to show their effects on Economy. The Fed Funds futures are currently discounting an 74% probability of a 50bps rate cut for the decision, which would come out at 1415 EST or 1915 GMT.
The reasons of the rate cut (Economy weakening or the recent Soc Gen issue) have already been discussed by a number of other notable economists/writers; we would like to focus on what are the things, which one should watch out for in the interest decision. The three most immediate things are….
1) Extent of Cut
2) Voting Pattern
3) Fed Statement
Extent of Cut: The extent of the cut in the Fed funds rate and the discount rate is most likely to have the biggest impact on currency and the stock markets. The latter is likely to impact the currencies too, given the carry-trade connection. Any cut less than that of 50bps is likely to be big negative for the stock market and therefore, it could lead to carry-trade unwinding.. i.e. Dollar falling against Yen rallying against high yielders.
On the other hand, a cut of 50bps could bring immediate relief to carry-trades and would be good for USD against Yen and Bad for USD against other high yielders.
The chart of the Fed Funds Rate and the US 12-Month Libor from 2000 is given below, with the expected rate given in RED. Note the previous rate cutting cycle in 2000-2002, relative to the current cycle.
Voting Pattern: New year brings a new Fed to the markets, as there has been a change in the voting members in the Federal Reserve board. Four members who were voting in December-07 would not vote in this meeting. The important thing is that the intra-meeting cut last week was done with the consent of the "Old Fed".
Important changes, from those who would not vote are Hoeing (voted for no cut in Sept-07) and Rosengren (voted for a 50bps cut in December-07). William Poole is another outgoing member who did not vote for an intra-meeting cut last week. Charles Evans would too not vote. Among the new entrants, the most notable is Charles Plosser, who has a reputation of being a hawk. The other incoming members include Gary Stern, Sandra Pianalto and Richard Fisher.
The voting pattern at this meeting is likely to act as a guidance for next several meetings, especially to judge the individual members degree of Hawkishness / Dovishness. There is a good chance that some members would vote against a cut.
Fed Statement: The Fed statement with the "Intra-meeting" cut last week was very dovish citing heightened concerns on Growth and little concern on Inflation. On growth they had said "Appreciable downside risks to growth remain". On Inflation they said "The Committee expects inflation to moderate in coming quarters".
The statement from tomorrow's meeting would be very important, as the Fed may be reluctant to cut "too quickly and too fast", especially if they cut by 50bps tomorrow and become "ahead of the curve". One possibility is a cut of 25 bps and a dovish statement, opening door for another "intra-meeting" cut, should the economic conditions deteriorate. Note that US NFP and US ISM both are out on Friday and are likely to show the extent of the deterioration in economic conditions. On the other hand, another possibility is a cut of 50bps accompanied with a hawkish statement.
These are some of the issues, which should be on one's radar going into the Fed meeting. Further Light trading positions would be preferred given the various uncertain results, which could come out from the meeting. However, selling $-Yen on a rally (if a 50bps cut is seen) would be the most preferred option.
Trade Wise, Trade Well!
Kshitij Consultancy Service
http://www.fxthoughts.com
Legal disclaimer and risk disclosure
These views/ forecasts/ suggestions, though proferred with the best of intentions, are based on our reading of the market at the time of writing. They are subject to change without notice.Though the information sources are believed to be reliable, the information is not guaranteed for accuracy. Those acting in the market on the basis of these are themselves responsibly for any profits or losses that might occur, without recourse to us. World financial markets, and especially the Foreign Exchange markets, are inherently risky and it is assumed that those who trade these markets are fully aware of the risk of real loss involved.
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