Market Focus Shifts to FOMC by Korman Tam

Japan’s Market Closed for Holiday
At 5:00 AM Eurozone July Trade Balance (exp 6.8 bln euros, prev 7.8 bln euros)
At 8:30 AM US September NY Fed Manufacturing (exp 18.0, prev 25.06)

The greenback remains mixed against the majors, mired near all-time lows versus the euro around 1.3865 but firmer against the yen and the sterling. The week will kick off to a slow start with the Japanese market closed in observance of the Respect for the Elderly Day holiday. The primary focus among traders will be the FOMC monetary policy meeting on Tuesday, in which market participants are anticipating a 25-basis point rate cut to 5.00%.

While an FOMC rate cut this week is not a foregone conclusion, recent deterioration in US economic fundamentals have raised speculation that the Fed will need to preempt a potential recession by easing policy to stimulate the economy. However, board members have delivered conflicting messages, with some maintaining their mantra of keeping inflationary pressure in check. It will be interesting to see whether the Fed responds to market calls for a cut while concurrently tempering inexorable expectations for further easing over the coming months. If a 25-basis point reduction does materialize on Tuesday, Bernanke will likely perform a balancing act between quelling burgeoning recessionary fears and containing runaway expectations for a series of rate cuts – given lingering concerns from Board members about inflation.

Recent price action in the currency market suggests traders have priced in a 25-basis point rate reduction this Tuesday, which increases the significance of the Fed’s subsequent statement and any post-meeting comments from FOMC Board members. We expect the greenback to remain under pressure over the coming months given the state of the US housing market and the subprime mortgage meltdown. In the week ahead, US economic reports will include the September NY Fed manufacturing survey, August CPI, PPI, July TICS, September NAHB, building permits and the Philadelphia Fed survey. It will also be important to focus on earnings reports from major financial firms that will be releasing this week to assess the full impact of the subprime debacle on their balance sheets.

Former Fed Chairman Greenspan was quoted in the FT as saying the US housing price declines will be more significant than most expect. He said he would not be surprised if US house price declines extended into double digits. However, he cautioned against cutting rates too aggressively for fear of an “inflationary resurgence”, which are greater now than when he was Chairman. Greenspan also added that the negative wealth effect from the housing slump results in a crisis that is “trickier” to control.