The focus on interest rates has taken center stage once again as we close in on another pivotal Federal Reserve decision, set for Thursday.  With plenty of reasons for all types of speculation, one thing is for certain: that Fed policy makers will decisively raise benchmark rates for a seventeenth consecutive time.

Considered one of the most aggressive tightening cycles in 25 years, the current regime will now have lasted past two years time and for a total of 400 basis points.  This compares to the most recent run 12 years ago when central bankers lifted the rate higher by 300 basis points over a 362 day period.  Impressive.  But what will happen with decisions thereafter?  Will central bankers continue to raise interest rates while keeping their hawkish bias, or will they turn dovish?  To answer this question, we dive into five probable scenarios and reference good old fashioned fundamentals.

Raise by 25, Keep Statement Unchanged (Likelihood: High) (Initially Dollar Bearish)

Raising rates by a quarter of a point and maintaining an unchanged and yet still hawkish statement is the most likely scenario that the Fed will deliver tomorrow. Here, policy makers will keep to the current bias that has been confirmed by recently positive US economic data - namely solid gross domestic product growth and improving manufacturing conditions.  This option signifies that the Federal Reserve is still looking to raise rates, but gives them the flexibility to react to incoming data over the next month and to adjust their monetary policy if needed.  Remember, they have a full month until the next meeting.  With Bernankeâ�,��"�s credibility in question, to raise by a quarter point and then to change the statement means that the Fed will have to follow through with the changes â�,�“ may it be to not raise rates again or to deliver another quarter point rise in August.  At this juncture with core inflation still slightly above their comfort zone, flexibility is what the Fed needs.  Not changing the statement leaves all options open for them to shift any way they deem fit either at or before the August meeting.  This scenario will keep the market still guessing and will probably be initially bearish for the dollar as many traders had hoped for more.

Raise by 25, Continue Bias to Raise Rates (ie. remain hawkish) (Likelihood: High) (Dollar Bullish)

Another equally possible scenario is for the Federal Reserve to raise rates by a quarter point and then to toughen up their stance on inflation, which would signify to the market that the central bank is committed to raising rates again in August.  This degree of hawkish will keep dollar bulls seek high yield in the market for longer and push the US dollar even higher against the yen and the Euro.  USD/JPY will in fact probably see the biggest upward reaction in this scenario because the yield differential between the two currencies is the widest and the Fukui scandal for the time being will continue to cap gains in the Yen.  The Euro will also sell-off against the US dollar, but the rally will probably be the most pronounced against the British pound given the stark contrasts between the Bank of England and the Federal Reserveâ�,��"�s monetary policies. 

Raise another 25, Shift to Neutral (Likelihood: Medium) (Dollar Bearish)

Another slightly less likely, but still very possible scenario is for the Fed to raise rates by 25 basis points to 5.25 percent and to shift their bias to neutral.  Calls for a neutral bias at this point are a bit stretched, especially when taking into consideration the recent spate of positive data in the US as well as the fact that the market has already began to price in the possibility of an August rate hike.  Consumer confidence is up, according to the Conference Board in the month of June, and is likely to reflect a more positive spending environment.  In addition, manufacturing upticks in the Chicago and New York have added to the current growth prospects.  Even the housing market is still holding up against rampant predictions that it will collapse.  The only factor that could spark a neutral bias possibility would be employment prospects.  Although suggesting job creation in the first half of the year, the nonfarm payroll employment report was horrid last month having only created a dismal 75,000 positions.  The figure has also fallen considerably below estimates for the past quarter, mildly suggesting that slower growth can be expected in the coming quarters.  Although posing a concern, the pessimistic results look to thinly affect the decision making process, with plenty of hawkish material to draw from.  However, if this occurs, it is the worst possible scenario for the US dollar because it signals that the Fed is done. 

Surprise, Surprise - Hike by 50 Move to Neutral (Likelihood: Low) (Mixed Reaction, Initially Dollar Bullish, then Bearish)

Another possibility is to raise rates by 50 basis points while also signaling an end to the current tightening cycle.  Definitely an aggressive option, the decision may not be that far from the truth as Federal Reserve policy makers have been known to show a â�,��"game time faceâ�,� in crunch time.  During the Greenspan years, in order to curb the rapid growth seen in the late 90â�,��"�s, Federal Reserve officials rattled markets by raising the benchmark by 50 basis points to 6 percent.  The decision may once again be made this time around for two simple reasons.  First, positive economic reports as of late have alluded to a rapidly expanding economy where previously hiked rates apparently havenâ�,��"�t done any good in curbing higher prices.  Secondly and most critically, the current board may see it fit to be aggressive this time around to stiff arm inflationary prospects and to put an end to the tightening cycle.  However, the decision may in fact spell doom for the dollar as the neutral or more dovish bias will likely send greenback lovers packing.  With the end of the tightening cycle imminently displayed, foreign global investors will refocus their attention to the growing US deficit and seek higher rates of return elsewhere. 

Not Likely - Hike by 50 Maintains Hawkish Bias (Likelihood: Low) (Dollar Bullish)

Ultra-aggressive proponents see the Federal Reserve as increasing interest rates by another 50 basis points while remaining steadfast in their currently hawkish assessment.  A possibility yes, but the likelihood remains the thinnest even as the current rate of core inflation has the Federal Reserve extremely worried.  Taking a look back, core consumer prices were running higher by 2.6 percent in the beginning of 2001.  Here, Federal officials actually enacted a 50 basis point rate cut in order to spur further spending and investment in a lack luster recessionary environment.  To make a timely comparison, consumer prices are now running at a 2.4 percent clip, hardly evidence enough to push the envelope on drying up liquidity in the worldâ�,��"�s largest economy.  Subsequently, adding to the unlikelihood is the recent pullback in commodity prices.  Readers will remember that one of the attributors of higher global prices were commodity valuations that were through the roof.  Base metals increased by an average of 75-80 percent and higher crude oil spurred concern that prices passed to consumer would be exorbitant.  In order to prevent these effects, the Fed resolved to keep pace with higher commodities.  Basic material prices have now stabilized with some weaker, reducing future inflation risks somewhat, but if the Fed still opts to be this aggressive, the EUR/USD could hit 1.2400 in a heartbeat. 

Positioning Post FOMC

Predicting what the Federal Reserve will do tomorrow afternoon is extremely difficult, but positioning post FOMC is much less so. 

If the Fed picks a dollar bullish scenario, the dollar rally will be most pronounced against:

New Zealand Dollar - Kiwi is suffering from poor data and central bank talking down currency

British Pound - Outlook for a Q3 or Q4 rate hike uncertainty after death of monetary policy committee member Walton

Japanese Yen - Most attractive interest rate differential, Yen is suffering from Fukui scandal

It will be least pronounced against the:

Euro - ECB recently turned more hawkish, looking to hike rates themselves

Alternatively, if the Fed picks a dollar bearish scenario, the opposite is true, the dollar will sell off the most against the Euro and much less so against the New Zealand dollar, British pound and Japanese Yen. 

Richard Lee is a Currency Strategist at FXCM.