Federal Reserve Is Expected to Announce Another Reduction but Sce

The failure of the housing market to bottom despite the measures taken by the U.S. government and Fed remains an albatross for the economy and a worry for investors. The latest signs of economic distress came hours before Federal Reserve policy-makers were expected to announce another reduction in official interest rates, and the data was likely to fan speculation they could cut by even more than the anticipated half percentage point to ward off deflation risks. Governor King in his letter of explanation made it clear that inflation will continue to fall and that in 2009 a letter to explain why the rate has fallen more than 1% below their target may be needed.

Despite, the improved outlook for the future the drop in the current situation assessment demonstrates how dire things currently are in Europe. Therefore, investors are expecting the central bank will need to continue their current easing policy which may limit upside potential for the Euro. In a similar fashion to the Euro, the British Pound has breached resistance but the bullish reversal has been less profound than that in the Euro. The weak data will reinforce fears over the UK economy which is likely to prevent more than a limited corrective recovery for Sterling. The Euro has given back some of its recent gains after the region’s PMI reading showed further contraction in both the manufacturing and service sectors.

The US Dollar has retreated against the major forex currencies over recent days, suffering most at the hands of the Euro and the Japanese Yen. Prices are now poised to test pivotal support and it suggests the current retracement may be ready to turn over. The FOMC is expected to cut its benchmark interest rate by 50 bps bring it to a record low of 0.50% which could add to the dollar’s recent weakness. Although the central bank is running out of room with rates at 1.00%, the fragile state of the economy is forcing their hand and leading them toward a zero interest rate policy. Inflation and housing data are due to cross the wires before hand and are expected to strengthen the case for further easing.

However, if we see prices ease less than expected, it could raise inflation expectations which may lead the central bank to keep rates on hold, which could send the dollar soaring. All that said if we remain extremely cautious as we are right now, any bailout or extreme rates cut will do little to restore confidence in the banking system and to drive us out of this crisis. Risk aversion will make all the upside scenarios less optimistic.