The Federal Open Market Committee (FOMC) will meet on August 11th and 12th. The FOMC interest rate decision and policy statement will be released on Wednesday August 12th. The FOMC is expected to hold rate policy steady at 0.00-0.25%. The trade will be looking to the FOMC policy statement accompanying the rate decision for clues to whether the FOMC will expand quantitative ease or signal a timeframe for an exit strategy from quantitative ease. The trade will also look to the FOMC statement to see if FOMC discussed the possible timing of when to begin hiking interest rates and the Fed's outlook for the US economy.

FOMC may let the bond purchase plan expire
In March, the FOMC announced quantitative ease and a plan to buy $300 bln in US treasuries over a six month timeframe. The quantitative ease was implemented to try and lower long-term bond yields and boost liquidity in the financial markets. The timeframe for the FOMC purchase of the 300 bln in US Treasuries will expire in September. The trade expects that the Fed will let the Treasury purchase plan expire in September. This could be the beginning of the exit strategy from quantitative ease.

No expansion of quantitative ease likely
In light of recent improvement in US economic data, including last Friday's release of better than expected July unemployment report, the FOMC is unlikely to expand quantitative ease. Last week the Bank of England (BOE) surprised the markets and expanded quantitative ease despite recent UK economic data that showed improvement. The FOMC is not expected to follow the surprise action by the BOE because of the divergence in inflation outlook in the UK and US. At the June FOMC meeting, the Fed made few changes to its policy statement save for the fact that it eliminated a statement about deflation risk. The elimination of deflation language from the FOMC statement indicates that the Fed is no longer concerned about deflation risk in the US. In contrast, the BOE remains concerned about deflation risk in the UK. Monday's Daily Telegraph suggests that the UK may face a Japanese-style lost decade of deflation risk. The FOMC expects the pick in the US economy to reduce the risk of deflation. The FOMC decision on quantitative ease and inflation outlook is important for the direction of the USD. GBP has traded lower since Thursday's surprise BOE announcement to expand quantitative ease and extended losses to start the week pressured by increased deflation fears in the UK.

FOMC officials may try and dampen rate hike speculation
The FOMC must balance the potential inflation risk presented by its quantitative ease policy and an expanding US government deficit spending. The combination of aggressive FOMC monetary ease and large government fiscal stimulus if left unchecked could eventually fuel a sharp rise in inflation.  At some point the FOMC will signal an exit strategy from quantitative ease. The FOMC is not likely to announce an exit strategy until convinced that the US economic recovery is sustainable. The timing of a possible Fed rate hike is beginning to emerge as an issue facing the financial markets. US bond yields have spiked higher in reaction to improving US economic data and stronger equity market trade. The FOMC may to try to dampen speculation that interest rates will be hiked anytime in the near future. Fed fund futures are pricing the possibility of a 25 bps rate hike at the start of 2010.

Look for a more upbeat economic outlook from the FOMC
In the June FOMC statement the Fed upgraded its GDP forecasts to -1% from original forecast of -1.5% for 2009 and the FOMC looks for 3.3% GDP growth in 2010. This was revised up from original forecast of 2.1%. The FOMC also raised its inflation forecast. The Fed closely monitors the PCE price index to gauge inflation. In June, the FOMC raised its PCE core inflation forecast to 1.3% to 1.6% in 2009 and 1.0% to 1.5% in 2010.

The FOMC meeting is likely to be a non-event. The FOMC is expected to express cautious optimism about the US economic outlook, restate that economic conditions warrant a low-level Fed funds for some time and make no increase in the level asset purchases. If the FOMC signals a timeframe for the end of quantitative ease the USD could extend its current rebound. A surprise extension of quantitative ease would likely send the USD sharply lower. Since an extension of quantitative ease is unlikely and the FOMC is expected to be more upbeat about the US economy, the meeting may be a mild positive for the USD.