FOMC Instant Insight: Fed Holds Onto Its Ammunition

September 16, 2008

To the surprise of the financial markets, the Federal Reserve left interest rates unchanged at 2 percent. Going into the meeting, everyone thought that the Fed was backed into a corner and would have no choice but to cut interest rates by 25 and possibly even 50bp. Although the tone of the FOMC statement was relatively cautious, the action or more specifically, the lack of action by the Federal Reserve indicates that they are not going to bend to the market’s pressure.

Side by side comparison of the 2 most recent FOMC Statement

One of 2 things probably compelled the Federal Reserve to hold back today - with liquidity injections and 325bp of easing since August 2007, they probably believe that they have done enough. Or they have injected so much liquidity into the financial system today that they want to give the markets the opportunity to respond. If things get worse they can always cut interest rates in October or between monetary policy meetings.

Equity traders are not going to like the outcome of the Fed meeting because they were hoping that a rate cut would help to stabilize the financial markets and prevent another bloodbath in the stock market. At this point, the Dow hitting 10k is not only possible but increasingly probable. Keep an eye on AIG. Without the help of the Fed, things could get worse for the banking sector.

For the US dollar, this is good news because the recent correction was triggered by the readjustment of interest rate expectations. Now that the Fed has failed to deliver, dollar bulls have a reason to jump back into the markets, especially with the stimulative impact of $91 a barrel oil. We expect the downtrend in the EUR/USD and GBP/USD to resume. USD/JPY should also trickle lower as US equities sell off.

Posted in FOMC, FOMC Minutes, Federal Reserve, forex blog