Many FOMC members appear very concerned about current conditions and the outlook. With the bank’s inflation bias eliminated from their statement on August 17th and the economy steadily deteriorating, there is little doubt that the Federal Reserve will cut the Fed Funds rate on September 18th. The question is: will it be by 25bps or 50bps?

Yield Spread Analysis 09/04 – 09/11

Risk aversion gave a boost to government bond markets once again over the past week, pushing global rates down. With economic outlooks sounding relatively dour, longer term rates took the biggest hit and have sent yield curves to invert substantially. In the US, last Friday’s non-farm payrolls figure led traders to ramp up speculation of a rate cut on September 18th, but the big question for the markets is: will it be by 25 basis points or 50 basis points? Currently, Fed Fund futures are betting on the former, but if additional signs emerge of deterioration in the economy, the contract could start to reflect a sharper cut. Meanwhile, other global markets remain concerned that a slowdown in the US will hurt growth prospects for their own economies.

Looking ahead, the Swiss National Bank will convene for their quarterly monetary policy meeting and announce their rate decision on September 13th. The bank is widely expected to raise rates, but Swiss bonds will likely respond to the SNB’s inflation and growth outlook, as signs that they will pause on their rate normalization cycle could send yields plummeting.

US Fed: It’s Not A Matter Of If They Will Cut, But By How Much

Many FOMC members appear very concerned about current conditions and the outlook. With the bank’s inflation bias eliminated from their statement on August 17th and the economy steadily deteriorating, there is little doubt that the Federal Reserve will cut the Fed Funds rate on September 18th. The question is: will it be by 25bps or 50bps?

Randall Kroszner, Federal Reserve Governor (Voter)

“If current conditions persist in mortgage markets, the demand for homes could weaken further, with possible implications for the broader economy and financial stress has not been limited just to mortgage markets, but has spread to other markets.” – September 6, 2007

Frederic Mishkin, Federal Reserve Governor (Voter)

“Economic activity could be affected more severely in other sectors should heightened uncertainty lead to a broader pullback in household and business spending.” – September 10, 2007

Janet Yellen, Federal Reserve Bank of San Francisco President (Non-Voter)

“There is significant downward pressure on the US economy from weakening in the housing sector and tightening of financial markets.” – September 10, 2007

Über-hawk Fisher clearly sees no need for a rate cut, but unfortunately for him, he is not a voter this time around:

Richard Fisher, Dallas Federal Reserve Bank President (Alternate Voter)

“The job of the Federal Reserve is not to bail out risk-takers: You're a big boy, you take risks, you bear the consequences.” – September 7, 2007

Former Fed Chairman Greenspan offers a very gloomy perspective:

Alan Greenspan, Former Federal Reserve Chairman

“The behavior in what we are observing in the last seven weeks is identical in many respects to what we saw in 1998, what we saw in the stock-market crash of 1987, I suspect what we saw in the land-boom collapse of 1837 and certainly [the bank panic of] 1907.” – September 7, 2007

ECB: Still A Chance For A Hike To 4.25%

With many European central bankers still calling monetary policy accommodative, the door has been left open for another rate hike to 4.25 percent this year. However, it will first need to be made clear to the European Central Bank that the impact of the turmoil in the financial markets is limited:

Jean-Claude Trichet, European Central Bank President

“The Governing Council will monitor very closely all developments. On the basis of our assessment and by acting in a firm and timely manner, we will ensure that risks to price stability over the medium term do not materialize and that medium-term inflation expectations remain firmly anchored in line with price stability.” – September 6, 2007

“Monetary policy is still on the accommodative side.” – September 6, 2007

Lucas Papademos, European Central Bank Vice-President

“The recent financial market turbulence hasn't affected the baseline scenario for medium-term economic growth in the euro area. The most likely outcome for medium-term growth is still favorable.” – September 7, 2007

Axel Weber, European Central Bank Governing Council Member

“We still see upward risks to price stability. The ECB is sticking to its baseline scenario that the euro zone economic growth is robust.” – September 7, 2007

Erkki Liikanen, European Central Bank Governing Council Member

“Risks to price stability are on the upside. We have to keep this in mind and follow economic developments very closely…The impact is negative (regarding current market turmoil). The question is how negative it is? If the situation is over, the impact could be limited. But one has to be cautious before taking a stance…It's an issue of months, rather than weeks, before financial markets return to normal.” – September 10, 2007

Is this wishful thinking by Spain’s Solbes, where the national housing market is in distress?

Pedro Solbes, Spanish Finance Minister

“We (in the Euro-zone) are almost at the point where rates will stabilize...and in fact may even begin to come down.” – September 10, 2007

Terri Belkas is a Currency Strategist at FXCM.