What the Fed Do Over the Next Few Months <http://www.dailyfx.com/story/special_report/special_reports/What_Could_the_ Fed_Do_1187801957652.html> :
1 Rate Cut in September, 1 Rate Cut in October A 25 basis point cut on or before the September 18th meeting followed by another rate cut before Christmas is very much priced into interest rate futures and has been ever since August 9th, when the liquidity crunch initially hit bond and equity markets. In fact, just a day prior, the markets were pricing in only a 20 percent probability of a September cut and 100 percent chance of only one 25bp reduction by the end of the year. This slower approach to loosening monetary conditions may be preferred by the Federal Reserve, as Bernanke will likely want to allow time to gauge the impact of their previous policy actions. Furthermore, the US dollar, carry trades, and equity markets may be more even-keeled in coming months as a less extreme policy move in the near-term would create the potential for additional policy action in the long-term. Nevertheless, traders should count on a spike in volatility on the announcement of any policy decision. 50bp Cut in September As we mentioned above, a 25 basis point interest-rate cut is already priced in for September, but what about a more dramatic cut? At the time of writing, futures show that traders see a 54 percent chance of a half-point cut to 4.75 percent, down from 90 percent on Tuesday but up from zero percent a week ago. If the markets continue to experience major volatility and equity markets start to get pummeled once again, the probabilities of such a move will only increase. Over the next few months, a 50 basis point cut may prove to be the most bullish for equity markets, who will breathe a sigh of relief, but bearish for the US dollar as interest rate differentials would be quickly out of favor for the currency. No Rate Cut in September, 1 Rate Cut in October At the moment, a decision by the Federal Reserve to leave rates unchanged in September appears to be the most unlikely scenario. While we have seen equity and bond markets start to calm down, Wall Street still appears to be anxious for some sort of policy action by the Federal Reserve in the near-term, and at this juncture, one of the central bank's main goals is to prevent a panic, which could occur if the markets don't believe that they will receive any assistance. However, this could also be the most bullish for the US dollar and bearish for carry trades, as risk aversion would rocket higher once again. Salam
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