After the sharp volatility in the currency and equity markets during the Asian and European trading sessions, the US session was relatively quiet up until the last 10 minutes of trading. For most of the US session, stocks oscillated between positive and negative territory, giving traders hope that we may be finally seeing some stabilization. The last hour of trading has been wrought with surprises and today was no different.

The Dow tumbled more than 200 points 10 minutes before the market closed, driving all of the major currency pairs down with it. As we have seen throughout the past week, the US dollar and the Japanese Yen have been the biggest beneficiaries of equity market weakness. In this nervous market environment, investors do not need a reason to sell. With no buyers in the market, we have seen a low volume late day liquidation.

Going into the Asian trading session, this should lead to more weakness for the EUR/USD and USD/JPY.

Pressure on the Fed to Cut Interest Rates

As the dollar continues to strengthen, the pressure on the Federal Reserve to make a larger interest rate cut has grown. Since the last interest rate cut by the central bank on October 8th, the dollar has rallied more than 8 percent and the Dow Jones Industrial Average has fallen by more than 10 percent. Going into the FOMC meeting, economists can’t seem to agree on how much the Federal Reserve will cut interest rates. Of the 64 economists surveyed by Bloomberg, 53 percent expect a 50bp rate cut, 26.5 percent expect a 25bp cut. Fed Funds traders appear to be more optimistic as they have already priced in 50bp of easing for Wednesday with a 32 percent chance of a 75bp rate cut. The only problem is that the next interest rate cut by the Fed will not be their last. The economy is expected to get worse before it gets better and the Federal Reserve will not want to back themselves into a corner quite yet; a larger rate cut on Wednesday would give them less room to cut interest rates in December.

Dollar Rally May Not End After Presidential Elections

If history can be a guide, the dollar rally may not end after the November 4th elections. In 6 out of the last 7 elections, regardless of whether Democrats or Republicans win, the US dollar has rallied in the 6 months following the election. With this in mind, central banks will have to take more aggressive monetary measures if they want to combat this historical trend.

Housing: Have We Hit a Bottom?

Both new and existing home sales bounced in the month of September, suggesting that the housing market may have bottomed. Although the data is certainly encouraging, it is important to realize that the increase is coming off of very low levels. The sale of inventory has also been driven by price cuts as home owners and developers become more desperate. The median price of a new home saw negative annualized price growth for the 5th month in a row. It will be interesting to see how the numbers fare in October because credit has been almost unattainable this month. Tomorrow we will receive the S&P/Case-Shiller Home Price Index, which can shed more light on the housing market. However it is important to realize that the data will be for the month of August and a lot has changed since then to make these numbers of little value in indicating a bottoming housing market. Consumer Confidence and the Richmond Fed Manufacturing Index are also due for release. The turmoil in the financial markets and the erosion of retirement accounts should weigh heavily on consumer sentiment.

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.