Last Tuesday, the FOMC caught investors off guard when they went through with not only a 50bp cut to the federal funds rate, but also a 50bp cut to the discount rate. The policy moves signaled two things: they are worried about a possible recession and they are concerned about the credit crunch. However, the ability of the Fed’s recent policy action to stop a recession is questionable, leaving traders wondering if they will cut rates further even in the face of mounting inflation pressures from food and energy price growth:

Ben Bernanke, Federal Reserve Chairman (Voter)

“Over the month of August the financial market turmoil has effectively tightened credit conditions. That has the risk of making the housing market correction more severe, and it may have other effects on the economy, so we took that action to try to get out ahead of the situation, try to forestall potential effects of tighter credit conditions on the broader economy.” – September 20, 2007

Donald Kohn, Federal Reserve Vice Chairman (Voter)

“In point of fact, Federal Reserve policy makers have not been asymmetrical in intent or actions, in that we have always focused sharply on the macro economy.” – September 21, 2007

Frederic Mishkin, Federal Reserve Board Governor (Voter)

“Controlling inflation is a key principle that has been developed over the decades and continues to guide US monetary policy today.” – September 21, 2007

Richard Fisher, Federal Reserve Bank of Dallas President (Non-Voter)

“If we had maintained the anti-inflationary course we had been following for more than 14 months by holding the federal funds rate at 5.25 percent, I believe we would have risked over steering our course and potentially run afoul of the shoals of unacceptably slow economic growth.” – September 25, 2007

Henry Paulson, US Treasury Secretary

“US economic fundamentals are healthy: unemployment is low, wages are rising and core inflation is contained. Although the recent reappraisal of risk, coupled with weakness in the housing sector, may well result in a penalty, the fundamentals point to continued US economic growth.” – September 20, 2007

ECB: With EUR/USD Above 1.40, Can the ECB Afford to Hike?

The European Central Bank has taken a lot of flak for their aggressive monetary policy stance as EUR/USD continues to breach new record highs. Commentary from members of the ECB is starting to sound defensive as they tout the greater inflation risks and the inability to use the exchange rate of the Euro as an instrument of economic policy:

Jean-Claude Trichet, European Central Bank President

“I would like to remind you that price stability and central bank independence have to be defended day by day because they will always be put to the test.” – September 21, 2007

“Central banks have done what (is) needed to be done in these circumstances (to deal with the crisis in the credit markets). Events of this kind always trigger turbulent episodes with a high level of volatility and could finally exceed the appropriate correction level.” – September 25, 2007

Axel Weber, European Central Bank Governing Council Member

“We know now that when viewed in the long-term perspective, the best contribution of monetary policy to appropriate economic growth and higher employment is to guarantee the price stability.” – September 21, 2007

Nicholas Garganas, European Central Bank Governing Council Member

“The upside risks to inflation dominate any effects stemming from the appreciation of the euro.” – September 25, 2007

Lorenzo Bini Smaghi, European Central Bank Governing Council Member

“For monetary policy to be targeted effectively at domestic objectives, rather than at those of another country, it has to be freed from any exchange rate commitment, i.e. the country must have a flexible exchange rate system…One key aspect is that the external value of the currency is determined by the financial markets. This means that the exchange rate is not - and cannot be - an instrument of economic policy.” – September 21, 2007

Nevertheless, the impact of a stronger euro will become very real for businesses in the Euro-zone, especially given its potential drag on export growth:

Fabrice Bregier, Airbus Chief Operating Officer

“If the euro remained durably at $1.45, that would mean we had to find 1 billion euros in additional savings under Power 8 (a restructuring plan drawn up with the euro at $1.35)…What we want is that the euro does not become even stronger and that eventually the European central banks take decisions in order to make the euro more attractive for exports from Europe.” – September 21, 2007

Terri Belkas is a Currency Strategist at FXCM.