US Fed: Dollar Bulls Prey On Tightening Bias, But Don’t Expect A Rate Hike Anytime Soon

The US dollar rally has been relentless, with the most recent push fueled by the minutes from the FOMC’s August meeting. Indeed, the Committee specifically stated that their next move “would likely be a tightening,” adding to already-building expectations that they would hike the fed funds rate from its current level of 2.00%. Currently, fed fund futures are pricing in at least a 25bp increase by March 2009, while Credit Suisse overnight index swaps are pricing in over 50bps worth of hikes within the next 12 months. The big question is: will they do it before year-end? Unlikely. While US economic data has appeared relatively solid compared to the UK and Euro-zone, growth has yet to recover and with the financial markets remaining unstable, the FOMC has little room to raise rates anytime soon.

Federal Open Market Committee Meeting Minutes (August 5)

"Although members generally anticipated that the next policy move would likely be a tightening, the time and extend of any change in policy stance would depend on evolving economic and financial developments and the implications for the outlook for economic growth and inflation…most participants anticipated that core inflation would edge back down during 2009…as the impetus from prior increases in the prices of imports, energy and other commodities abated and the margin of slack in resource use widened.”

“The weaker outlook for consumer demand, along with tighter credit conditions for businesses, was expected to weigh on business spending going forward.”

Dennis Lockhart, Federal Reserve Bank of Atlanta President (Alternate Voting Member)

“Although recent measures of inflation are higher than I would like to see, I would say that recent price increases are more likely to be transitory than persistent…I expect that CPI inflation will peak near the July level of 5.6 percent.”

“Taken as a whole, these measures suggest inflation expectations may have risen modestly -- but not by a material degree…By that I mean, not sufficient for me to think Fed policies have been off target with respect to the central bank's responsibility for price stability.”

Thomas Hoenig, Federal Reserve Bank of Kansas City President (Non-Voting Member)

“For the Federal Reserve, adding a more explicit financial stability mandate to its existing dual mandate for price stability and economic growth raises important and difficult questions about the compatibility of these responsibilities and the problems that might arise in attempting to achieve them all simultaneously.”

“The current stance of policy, while understandably calibrated for responding to the immediate financial crisis, will make it difficult to achieve our mandate for price stability over the longer term.”

“It should be clear that major nonbank financial institutions that seek discount window assistance will immediately come under Federal Reserve oversight.”

BOE: Can the Lone Dove Convince the MPC to Cut Rates?

Bank of England Monetary Policy Committee (MPC) member David Blanchflower has been by far the most dovish member of the bunch since he joined the bank in March 2007, voting for rate cuts during 12 of the past 18 meetings. Meanwhile, Chancellor of the Exchequer Alistair Darling added to UK recession fears over the weekend and unfortunately for the BOE, it appears that Mr. Blanchflower may have been correct in thinking that growth was of greater concern than rising prices. Thus, there is some potential for the central bank to surprise the markets with a rate cut this Thursday.

David Blanchflower, Bank of England Monetary Policy Committee Member

“The fears that I have expressed over the last six months have started to come to fruition…I've obviously voted on quite a number of occasions now for small cuts but we need to act and we probably need to act in larger amounts than that. We need to actually get ahead of the game and it appears that we are now behind.”

“We are going to see much more dramatic drops in output. The way to get out of it is to act, by interest rate cuts and fiscal stimulus and other things to try help people who are hurt through this…Sitting by doing nothing is not going to get us out of this and hoping that a knight in shining armor will come and lift us out of this is optimistic in the extreme.”

ECB: No Change In Rates, But Euro Could Suffer On Bearish Comments

The European Central Bank is widely expected to leave rates unchanged on Thursday at 4.25 percent, as they seek to balance upside inflation risks with downside growth risks. On net this shouldn’t have a large impact on the euro, but what could shake the currency up is commentary by ECB President Trichet, especially since he is likely to discuss the deterioration of the Euro-zone’s economies.

Lucas Papademos, European Central Bank Vice President

“It is likely the market adjustment process will continue for a considerable period of time and there is significant uncertainty about the impact on the broader economy…Looking ahead, the uncertainty which is surrounding the euro area's financial stability outlook is high and has increased. This assessment reflects a number of developments, some external and some internal within the euro area.”

Axel Weber, European Central Bank Governing Council Member

“Monetary policy at the moment is roughly where it should be and I think the discussion about declining rates in Europe is premature…If the economic outlook brightens somewhat again towards the end of the year and next year, which I still expect, we'll have to see if action is necessary.”

Lorenzo Bini Smaghi, European Central Bank Executive Board Member

“If the central bank decided to stimulate the economy by lowering interest rates this would have the effect of increasing inflation. Are we sure that is what we want?”

Terri Belkas is a Currency Strategist at FXCM.