The Fed’s bias is the key, here’s why…
All eyes are now on
today’s FOMC rate decision. Fed fund futures are currently pricing in a 94
percent probability that the Fed will be raising interest rates for the 11th
time to 3.75 percent.
Of the 1,300 people who took the DailyFX interest
rate poll, 89 percent expect interest rates to be increased again this year,
which means that even Katrina won’t be able to stop the Fed. Most of the
pre-Katrina economic data has been strong and in the words of Dallas Fed
President Fisher who is a voting member of the FOMC, they “don’t really knowâ€
how Katrina might alter the outlook for the US economy. Greenspan and company
will probably remain in wait and see mode until more Katrina inclusive data is
released. The data that we have received so far that would have included the
Katrina impact, have been bad — consumer confidence, manufacturing sector
sentiment surveys and jobless claims all worsened.
Unsurprisingly, the main focus should be on the
FOMC statement rather than the actual move itself. The Fed will probably use
this opportunity to buy themselves time. This would not be a first. Back in
March of 2003, right before the beginning of the Iraq war, the Fed said that
based upon the current situation, they could not appropriately assess the
balance of risks to growth and inflation.
The Fed’s job is just as hard this time around
since not only do they have to consider the possible economic impact of Katrina,
how much of a blow oil prices will deal consumers in the months ahead, but they
also have to consider the latest storm brewing off the coast of Florida. If this
becomes another big one, can the economy withstand a double blow by Mother
Nature? At bare minimum, even if Rita delivers little damage, we know that the
rebuilding of oil refineries hit by Katrina will be put on hold in anticipation
of the next storm. So even if Japan, Europe and OPEC offer more oil, with some
refineries still off line, there is a bottleneck in the production process that
could very well keep oil prices elevated throughout the fall.
It may be unavoidable though for the Fed to make
some sort of reference to Katrina. Will Greenspan succumb to political pressure?
Most likely, Greenspan will view Katrina’s impact as temporary, just as he has
previously viewed the rise in energy prices as temporary. They may even try to
downplay the significance of Katrina and look ahead to the positive growth the
rebuilding efforts may bring. Bernanke has already said that the Hurricane
effects are “transitory.†If there is any hint of the same optimism in the
statement, the market may interpret it as a sign of a sure fire rate hike in
November, which would be bullish for the US dollar.
On the flip side, if Greenspan shifts his tone
and acknowledges the potential uncertainty that Katrina poses to the economy and
that energy prices have been elevated for months now, the market could interpret
this as a slant towards dovish-ness, which would be bearish for the dollar.
So bottom-line, the market will be looking for
hints as to what the Fed may do in November.
Kathy Lien
Kathy Lien is the Chief Currency Strategist at
Forex Capital Markets. Kathy is responsible for providing research and analysis
for DailyFX, including technical and fundamental research reports, market
commentaries and trading strategies. A seasoned FX analyst and trader, prior to
joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross
Markets and Foreign Exchange Trading. Kathy has vast experience within the
interbank market using both technical and fundamental analysis to trade FX spot
and options. She also has experience trading a number of products outside of FX,
including interest rate derivatives, bonds, equities, and futures. She has a
Bachelors degree in Finance from New York University. Kathy has written for
Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO
Magazine. She is frequently quoted on Bloomberg and Reuters and has taught
seminars across the country. She has also hosted trader chats on EliteTrader,
eSignal, and FXStreet, sharing her expertise in both technical and fundamental
analysis.