Euro Stalls Ahead of Federal Reserve Interest Rate Decision (page 1 of 2)

DailyFX Fundamentals 01-29-08

By Kathy Lien, Chief Strategist of DailyFX.com

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