US$ Waiting on Fed Meeting, Market Expecting Interest Rate Cut

The US$ consolidated ranges overnight ahead of the beginning of the Fed’s two-day policy meeting to decide the direction of US interest rates. With the market widely expecting the Fed to lower interest rates 25 basis points, the US$ continues to remain under significant pressure. There does, however, remain significant jockeying around the prospect of the Fed lowering rates further after tomorrow’s action. Bill Gross, manager of PIMCO investment, the world’s largest bond fund asserted that he believes that the Fed will need to lower Fed Funds rates to 3.5% to stave off a recession. Rates currently stand at 4.75%. With the market on hold awaiting the Fed’s action and the accompanying statement, trade will likely remain in tight ranges today. Overnight US Treasury Secretary Paulson reasserted US support of a strong dollar and further stated that the US housing market will likely weaken further. Neither comment had much affect on the direction of the greenback. There is however, some economic data slated for release today, which could steer the direction of trade. At 10:00 a.m. Consumer Confidence data is to be released expected to decline to 99.0. Any signs of weakness from the US consumer, on the back of a declining housing market, could certainly weigh on the US$ further.

The euro fell modestly overnight as traders consolidate positions ahead of the Fed’s policy decision tomorrow. With the market widely expecting the Fed to push rates lower, focus remains on interest rate differentials between the US and Eurozone. As the Fed cuts rates, these differentials narrow, increasing the appeal of the euro. Add to the Fed’s rate cutting bias, the ECB and its apparent vigilance to inflation fighting. While analysts do not expect the ECB to hike rates when the Central Bank meets on November 8th, it is expected that they will reaffirm their hawkish posture. Expect this environment to continue to attract capital to the euro, boosting the currency to new highs.

The yen weakened overnight as investors continue to use the “carry trade” to finance positions in other financial markets amidst signs that Japanese interest rates will remain low at 0.5% for some time. It is expected that the Bank of Japan will lower its growth and inflation forecasts tomorrow as it keeps rates unchanged. Further supporting this view of lower rates is the environment of gaining unemployment in Japan. As Japan maintains an environment of low rates as signs of an economic slowdown materialize, the carry trade will persist, putting downward pressure on the yen. However, with uncertainty dominating equity markets and investors still hesitant about embracing significant risk, the yen’s losses will ultimately be limited. This will certainly regulate the yen to continue to trade in wide ranges.

The pound gained overnight to 26 year highs against the US$ as investors focus on high UK rates leading sterling higher. It is expected that the Bank of England will keep rates at six-year highs while the Fed continues its pattern of rate cuts. As the US economy continues to stumble, UK economic growth is proving to be surprisingly resilient. GDP expanded at a better than expected pace last quarter while consumer spending remains robust. Should any of these indicators show signs of weakness sterling could retreat, however, the pound will likely continue to remain robust as investors favor the pound, pushing it towards new highs.