Fed faces tough call - 31-10-07

The Federal Reserve is likely to face a series of tough decisions and this month's meeting is no exception as the Fed battles with persistent fears over recession and potential inflation risks.

The dollar's immediate reaction will be determined by the headline decision. Overall, there looks to be around a 65% chance of a 0.25% rate cut with a 25% chance that rates are left on hold and a 10% chance of a second successive 0.50% rate cut.

In headline terms, there should be a measured reaction to a 0.25% cut while the dollar will take another caning if there is a 0.50% rate cut. Unchanged rates would tend to strengthen the dollar sharply, although there could be a quick reversal on expectations that a cut has just been delayed until December.

As well as the decision, the statement will also need to watched very closely as it will be a key guide to the Fed's thinking on underlying trends. The Fed will need to retain as much flexibility as possible and is likely to say that future decisions will be dependent on forthcoming data.

A greater emphasis on inflation risks and confidence in the underlying economy would, however, represent a much more positive dollar backdrop than if the Fed concentrates on the downside economic risks.

The Wall Street and credit-market reactions will also be very important for the overall dollar direction, especially against Asian currencies.

Tim Clayton
Investica Ltd
E-mail: tim.clayton@investica.co.uk
+44 (0) 1452 781001