The U.S. Federal Reserve left the Fed Funds rate unchanged at 2 percent. However, the FOMC statement released after the rate decision was less dovish than expected and the U.S. dollar rallied against the world’s most heavily traded currencies. In fact, despite the recent turmoil in the world’s financial markets, the Fed is still very concerned in anchoring inflation expectations to promote price stability.

The Fed Expressed Deep Concern About the Recent Credit Crunch

Despite the unanimous vote to keep rates on hold, the U.S. Federal Reserve is concerned that the recent events in today's very volatile financial markets may have second round effects in the rest of the economy and push the United States into a much deeper recession. "Strains in financial markets have increased significantly and labor markets have weakened further", the Fed said. Indeed, earlier in the day, the Federal Reserve Bank of New York announced an injection of 70 billion dollars in repurchase agreements to ensure market liquidity and avert a violent credit crunch by having banks to lend to each other. In fact, money markets have been in considerable stress after the bankruptcy of Lehman Brothers, the acquisition or Merrill Lynch by Bank of America and rumors that AIG, one of the world’s largest insurance firms, could run out of cash. The next FOMC meeting is on October 29 and there is a 58.2 percent probability the Federal Reserve will cut rates by at least 25 bps, according to Fed Funds futures.

Looking Ahead Lower Oil Prices Are Likely to Help the U.S. Dollar

The currency market has been very volatile and a powerful wave of risk aversion has been helping lower yielding currencies like the Japanese yen. Yet, the U.S. dollar has been relatively strong over the past two months and we expect this trend to continue going forward. In fact, lower oil prices should help the U.S. economy by alleviating pressure in the U.S. consumer which makes nearly 70% of the U.S. economy. Looking ahead, the USD/JPY is likely to remain very volatile but I expect the EUR/USD to fall further. Recent economic data points towards a weakening of real GDP growth in the euro zone economy and the ECB will have no other choice than to cut rates faster than the U.S. Federal Reserve. Lower interest rate differentials could make the euro less attractive to carry traders and the lower level of demand for bonds and stocks denominated in euros could accelerate the losses in the EUR/USD.

Antonio Sousa is a Currency Analyst for FXCM.