US Fed: Will March 18th Bring Another Round of Rate Cuts?

While Federal Open Market Committee members don’t sound as aggressively dovish as they have in the past, there is no doubt that the large downside risks to growth that loom for the US leave Fed Chairman Ben Bernanke’s finger on the trigger when it comes to rate cuts. Fed fund futures are still betting on another 50bp reduction to 2.50% in March, but Wednesday’s release of US CPI and the FOMC January meeting minutes could shake up traders’ expectations. However, with the credit markets still jittery and financial institutions still facing subprime-related writedowns, Bernanke & Co. may have little choice but to continue the rate cut cycle they embarked upon 225bp ago in September 2007.

Yield Spread Analysis 02/12 – 02/19
Price action in the global fixed income markets has been eerily quiet over the past week as volatility in equity indexes has generally cooled down. Some exceptions include European and Australian bonds. Short-term European yields have jumped as it becomes clear that the European Central Bank maintains a hawkish bias, while both ends of the Australian yield curve have surged following the release of the minutes from the Reserve Bank of Australia’s most recent policy meeting. Indeed, the RBA hiked rates on February 5 by 25bp, but the minutes showed that the bank actually considered a 50bp increase, which significantly raises the chances that they will tighten monetary policy further in March.
This week, the release of US CPI and the FOMC January meeting minutes may shake up Federal Reserve rate cut expectations – though the latter will likely prove to be more market-moving. If the minutes show that the bank remains more concerned about growth than inflation, Treasuries could rise even further and drag yields down. On the other hand, signs of strong inflation pressures may lead traders to cut back on speculation that a 50bp cut is in the cards in March.
For a full schedule of upcoming event risk, see the DailyFX Calendar.

[B]US Fed: Will March 18 Bring Another Round of Rate Cuts?

While Federal Open Market Committee members don’t sound as aggressively dovish as they have in the past, there is no doubt that the large downside risks to growth that loom for the US leave Bernanke’s finger on the trigger when it comes to rate cuts. Fed fund futures are still betting on another 50bp reduction to 2.50% in March, but Wednesday’s release of US CPI and the FOMC January meeting minutes could shake up traders’ expectations. However, with the credit markets still jittery and financial institutions still facing subprime-related write downs, Bernanke & Co. may have little choice but to continue the rate cut cycle they embarked upon 225bp ago in September 2007.

Do you think the Fed has more rate cuts in store? Join the discussion in the [B]DailyFX Fed Watch Forum[/B].[/B]

Ben Bernanke, Federal Reserve Chairman (Voting Member)
“The Fed will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks…A significant worsening in financial conditions or in credit availability would certainly be a warning bell that we need to take further actions.” Nevertheless, he added: “Our policy stance must be determined in light of the medium-term forecast for real activity and inflation, as well as the risks to that forecast. … Any tendency of inflation expectations to become unmoored or for the Fed’s inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and reduce the central bank’s flexibility to counter shortfalls in growth in the future.” – February 14, 2008
“My baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year as the effects of monetary and fiscal policy stimulus begin to be felt.” – February 14, 2008

Janet Yellen, Federal Reserve Bank of San Francisco President (Alternate Voting Member)
“I consider it most probable that the US economy will experience slow growth, and not outright recession, in coming quarters." – February 14, 2008

Charles Evans, Federal Reserve Bank of Chicago President (Alternate Voting Member)
“The current federal funds rate is relatively accommodative and should support stronger growth…the effects of last fall’s rate cuts are probably just being felt, while the cumulative declines should do more to promote growth as we move through the year.” – February 14, 2008

Alan Greenspan, Former Federal Reserve Chairman
“If it weren’t for the fact that business was in such extraordinary good shape before this problem hit, I don’t think we’d be questioning at this stage whether we’re in a recession.” – February 15, 2008

ECB: Trichet’s Focus on Price Stability Set to Keep Policy Unchanged
[B]European Central Bank President Jean-Claude Trichet’s hawkish rhetoric has been hard to ignore over the past year, and he has yet to step away from his focus on price stability. While Trichet did drop the phrase noting that the “Governing Council remains prepared to act pre-emptively so that second-round effects and upside risks to price stability over the medium term do not materialize” from his post-ECB rate decision press conference, the specter of out-of-control inflation growth will likely prove too daunting to allow the central bank to even consider cutting rates in the first half of 2008.

How do you think this will impact the Euro? Discuss the topic with DailyFX analysts and other traders have to say about it in the DailyFX EUR/USD Forum. [/B]

Jean-Claude Trichet, European Central Bank President
“There have been recently signals that the disinflationary impact of low-cost countries on euro area import prices might be coming to an end due to increasing inflationary pressures in those countries. The recent increases in the prices of imports from low-cost countries might be interpreted as a sign that the downward impact from these countries is waning. Moreover, from a forward looking perspective, price pressures on soft commodities… appear to be a potential source of strong adverse relative price shocks. These developments clearly represent upside risks to price stability.” – February 15, 2008

Erkki Liikanen, European Central Bank Governing Council Member
“If we want to guarantee good economic growth, price stability is a prerequisite.” – February 15, 2008
“Economic growth is slowing also in the Euro-zone, as the confidence sentiment has weakened and the financial market turmoil is ongoing…this year, growth in the area will be below 2 percent according to current estimates…there are exceptionally many uncertainties in the short-term economic outlook at the moment.” – February 18, 2008

Axel Weber, European Central Bank Governing Council Member
“Financial market participants’ interest rate expectations don’t adequately reflect the risks surrounding the euro-zone’s inflation outlook that are clearly to the upside.” – February 15, 2008

Joaquin Almunia, EU Economic and Monetary Affairs Commissioner
“I see the main risk for the growth outlook is the continuation of turmoil on financial markets and at the same time the possibility of a more pronounced US slowdown. The final figure for growth in Q4 was slightly better than our last forecast, but we cannot ignore the deceleration of growth.” – February 15, 2008

Michael Glos, German Economy Minister
“The fundamental growth dynamic is still intact. The slight weakening of real gross domestic product in the fourth quarter had already been included in the forecast of our annual economic outlook report. Germany’s economy is still in positive growth, despite the current slightly lower pace.” – February 14, 2008

BOE: Will the Nationalization of Northern Rock Force a Rate Cut?
[B]While Bank of England Governor Mervyn King is keen to remain keep a “balanced view” of the economy, the status of the financial markets and its related sectors are of major concern to other Monetary Policy Committee members, especially in light of the nationalization of Northern Rock. With subprime related losses possibly still looming and just waiting to be claimed, UK policymakers’ fears are well-warranted and as a result, the BOE is likely to be still considering additional rate cuts. However, given the inflation worries cited in the most recent Quarterly Inflation Report, a reduction may not be on tap in March.

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Mervyn King, Bank of England Governor
“Consumers and businesses need to take a balanced view of the outlook for the UK economy and not be swayed by reports of doom and gloom coming from the financial services and property sectors.” – February 13, 2008

Tim Besley, Bank of England Monetary Policy Committee Member
“With credit conditions tightening, we might expect a significant reduction in consumption growth over the coming months.” – February 18, 2008
“Considerable weight should be placed on conditions in financial markets in understanding the transmission of monetary policy to the real economy … judging whether a given level of Bank Rate is restrictive depends importantly upon the conditions that prevail in financial markets at the time.” – February 18, 2008

Paul Tucker, Bank of England Monetary Policy Committee Member
“The upcoming banking reporting season will be crucial in solving the credit crisis.” – February 13, 2008

Gordon Brown, British Prime Minister
“The easy option would have been to take Northern Rock into public ownership immediately…that would have been wrong.” – February 18, 2008

Compiled by Terri Belkas, Currency Analyst, [I]Forex Capital Markets LLC, DailyFX.com

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