The minutes of the FOMC’s September 18th meeting showed that “all members agreed that a rate cut of 50 basis points at this meeting was the most prudent course of action." Meanwhile, the central bank said that they would consider more options "closely" after the September meeting, but that all future actions depend on the economy and market developments. Given the improvements we saw in last Friday's NFP report, the timeliest economic data could lead the FOMC to leave rates steady on October 31st. Furthermore, there have been signs that price pressures are building via energy and food, and with the FOMC minutes showing that the bank "remained concerned" about inflation as a continued decline in the US Dollar could raise inflation risks, Bernanke & Co. may be hesitant to slash the Fed Funds rate again so soon.

Yield Spread Analysis 10/02 – 10/09

Over the course of last week, yields in most regions worked higher as global equities rebounded, with the Dow hitting record highs. The most notable moves were seen in the US and Canada after last Friday’s US NFP report sent short-term yields rocketing higher. Furthermore, on Tuesday, the release of the minutes from the September 18th FOMC meeting suggested that the central bank may not cut rates again on October 31st. In fact, the minutes led the futures markets to move to only price in a 36 percent chance of cut, down from a 50 percent chance last week. Meanwhile, the short end of the European yield curve moved lower, as the ECB shifted to a far more neutral stance. On the other hand, short-term rates in the UK rocketed higher as the BOE did not issue a policy statement after their most recent rate announcement, signaling that conditions in the financial markets are no longer a major concern of theirs.

Looking ahead, the BOJ rate decision this week shouldn’t spark too much volatility, as the central bank is widely expected to leave rates steady. However, Friday’s US retail sales figure could trigger large moves in Treasuries and Canadian Government Bonds, as a surprise decline could cause concerns the consumer spending will take a large hit throughout the rest of the year, enhancing the risks of a recession.

US Fed: One and Done…For Now

The minutes of the FOMC’s September 18th meeting showed that “all members agreed that a rate cut of 50 basis points at this meeting was the most prudent course of action." Meanwhile, the central bank said that they would consider more options "closely" after the September meeting, but that all future actions depend on the economy and market developments. Given the improvements we saw in last Friday's NFP report, the timeliest economic data could lead the FOMC to leave rates steady on October 31st. Furthermore, there have been signs that price pressures are building via energy and food, and with the FOMC minutes showing that the bank "remained concerned" about inflation as a continued decline in the US Dollar could raise inflation risks, Bernanke & Co. may be hesitant to slash the Fed Funds rate again so soon:

FOMC Minutes from September 18th

“Participants made only modest revisions to their outlook for inflation...and they generally were a little more confident that the decline in inflation earlier this year would be sustained. Participants nonetheless remained concerned about possible upside risks to inflation. Higher benefit costs, rising unit labor costs more generally, reduced markups, and levels of resource utilization both in the United States and abroad that remained relatively high were all cited as factors that could contribute to inflationary pressures. Inflation risks could be heightened if the dollar were to continue to depreciate significantly.”

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

“The global economy is facing agri-flation, a period of rising food prices that may be more sustained than we would like and could last several years.” – October 5, 2007

“I think things are clearly better than they were back during that crisis period in August. It does take a while for a wound to heal and this process of healing is still at work…I don't think it is fair to say that the Fed has flooded the market with liquidity, which has gone straight into stocks. I don't think that is accurate.” – October 5, 2007

Frederic Mishkin, Federal Reserve Board Governor (Voter)

“Clearly exchange rates are an important asset price…(but) I have always argued very strongly that it is not a good idea to focus on asset prices like the exchange rate over and above the effect it has in terms of things we should care about as central banks. This is an issue right now with the highly appreciated Euro.” – October 5, 2007

ECB: Trichet Moves To More Neutral Bias

As was expected, the European Central Bank left rates at 4.00 percent last Thursday, but it was ECB President Trichet's press conference that garnered all of the attention. In his commentary, Trichet dropped the phrase noting that monetary policy remains "accommodative," and instead said that the central bank "stands ready to counter price risks" as "more information is needed to draw rate conclusions." In this, we can judge that Trichet & Co. are far less hawkish than in previous months amidst a combination of downside risks to growth along with upside risks to inflation. However, the Euro still remains lofty, allowing concerns of its impact on economic growth to percolate:

Jean-Claude Trichet, European Central Bank President

“To sum up, a cross-check of the information...has confirmed the existence of upside risks to price stability over the medium term, against the background of good economic fundamentals in the Euro area. Accordingly, and with money and credit growth vigorous in the Euro area, our monetary policy stands ready to counter upside risks to price stability, as required by our primary objective.” – October 4, 2007

Erkki Liikanen, European Central Bank Governing Council Member

“We must ensure that inflation expectations remain anchored in line with price stability. This is essential for sustainable economic growth and favorable employment development.” – October 8, 2007

Some ECB policy makers are trying to play down expectations for the G7 meeting on the weekend of October 19th, as many are wondering if the ECB or other officials will take the opportunity to talk down the Euro:

Lorenzo Bini Smaghi, European Central Bank Executive Committee Member

“An exchange rate policy for the Euro exists, and so does an institutional mechanism to enact it. However, to be effective, the impact on markets of monetary policy must be quick, sudden. To move, it's not necessary to wait for a G7 meeting.” – October 8, 2007

Didier Reynders, Belgian Finance Minister

“Inflation is very much under control. I think that rates should be held at their current level, with a view to relaxing the pressure later in the event of an unfavorable evolution in growth. What strikes me often is to hear ECB officials explain how the situation has changed, how it is worrying, without doing anything.” – October 3, 2007

Terri Belkas is a Currency Strategist at FXCM.