A very quiet night of trade in the currency market as a combination of a nearly empty economic calendar and the anticipation of the upcoming FOMC rate decision at 18:15 GMT kept most of the majors in very tight trading ranges throughout the Asian and European sessions. On the economic front German Industrial Production failed to meet expectations dropping -0.4% vs. 0.5% forecast, as some of the large Factory Orders seen in yesterday’s report did not make it through the system. Overall, IP did rise 5.1% on a year over year basis meeting analysts forecasts, but tonight’s news suggests that German GDP will see little growth contribution from the industrial sector in Q2 of 2007. The euro barely budged on the report as traders focus was fixed squarely on US economic developments rather than Euro-zone’s.

Yesterday’s rebound in US equities reversed the yen rally earlier in the day as investors speculated that the US government will take steps to ameliorate the growing crisis in mortgage lending. The latest bankruptcy amongst mortgage brokers with the collapse of AMH has had a chilling effect on the credit markets. While 10 year bonds rates have been falling, 30 year fixed jumbo mortgages jumped to 7.34% from 7.1% according to a survey by HSN Associates. The atypical divergence suggests a repricing of risk as lenders continue to worry about the credit worthiness of home buyers and will likely have ripple effects throughout the US economy slowing consumption and employment growth as we approach the fall season.

The Fed however is caught between a rock and a hard place, as it must on one hand continue to maintain its inflation fighting credibility and on the other make sure that current troubles in housing do not tip the US economy into a recession. Most market analysts expect no change of tone and certainly no change of policy from FOMC. However, as we noted in our weekly, “any change in the language by Dr. Bernanke and company that acknowledges the growing problem in the credit markets may be viewed as precursor to a rate cut and could cause further dollar selling.” Therefore, while trading has been lackluster so far, volatility may pick up considerably later in the day if the FOMC communiqué produces any surprises.

Boris Schlossberg is a Senior Currency Strategist at FXCM.