All Eyes on the Federal Reserve This Week

Tuesday, 2 November 2010

Currency markets have been relatively quiet to start this week, with all of the attention of investors going towards the US Federal Reserve awaiting the Wednesday announcement of the latest developments in monetary policy. The Fed is set to release its opinion on the state of the US economy on Wednesday ET Time, and the jury really is out as to what exactly is going to happen in relation to the policy.

Many people believe that the Fed will announce another round of quantitative easing measures - but will restrain itself to only a few hundred billion dollars. Obviously, this will not put them on par with the curve, but will at least give the market some confidence that they are concerned about future growth in the economy.

A further package of monetary easing (quantitative easing) will have a tangible effect on the currency markets, as any further printing of money (essentially what quantitative easing really is) will dilate the existing currency in flow in the economy.

Thus, essentially the USD will be worth less dollar for dollar, and therefore we should expect to see a weakening of the USD. However -because the rumour of more quantitative easing has been around for a fair amount of time now, the market has had ample time to incorporate this in to the pricing of the USD. Hence, the current rate in the market against a basket of currencies - including the Euro and the Yen - all reflect the idea that the Fed will release a further $400 to $600 billion in to the market.

What will make the market move further (or jump / fall surprisingly) is if the Fed announces measures which are outside of this already predicted range. If, for example, they announced a $1 trillion package to the market - the currency would drop like a fly - possibly to around 1.5000 EUR/USD.

Alternatively, if the figure is more modest, at $200 billion - the currency should rise in accordance with the level of the figure. As you can see, until the announcement is actually made on Wednesday - the best we can do is guess where the level will come in at, and plan our trades with a good amount of risk limiting at the same time.