What next for US monetary policy?
After a month of dramatic developments in the currency markets, focus now turns to the the US Federal Reserve which is taking place on 20-21 September. This meeting has been extended to two days in order to discuss and decide upon changes to interest rates and whether to execute QE3. This meeting comes at a critical time for the dollar's future and investors should tune in at 18.15GMT on 21 September to hear the outcome of the Fed's decision.
Since the $600 billion quantitative easing (QE) program ended in June, economic data has shown alarmingly weak figures at a time when the US economy was expected to be undergoing steady recovery. Retail sales stalled in August, the manufacturing index showed a contraction in September, while Non Farm Payrolls showed zero increase in employed Americans in August. Data also shows housing market figures sank and consumer confidence plunged to the lowest level for two years. Those numbers paint a negative picture for the future of the US economy, raising expectations that the Fed may take further steps to boost the economy.
During the Jackson Hole meeting, the Fed President Ben Bernanke announced that the next policy meeting will be extended to two days in order to discuss the several tools that may be used to provide additional monetary stimulus. This has left investors speculating that if quantitative easing is on the Fed policymakers' plans then it will be announced at the September meeting. Bernanke emphasised on the severity of the recession in the US and the risk that the eurozone debt crisis poses to global economic growth.
It is expected that the Federal Open Market Committee (FOMC) will keep interest rates unchanged between 0-0.25 percent. A third round of quantitative easing is expected to be discussed at the meeting but the recent jump in inflation may prevent the Federal Reserve from engaging in a new bond purchasing scheme. The absence of what is known as QE3 may be a catalyst for a US dollar rally supported by a heightened risk aversion in the market. The equity market may turn negative and gold may rally to fresh highs.
A more likely scenario is the announcement of a policy called Operation Twist. With this policy, the Fed would replace short-term debt with longer debt bonds resulting in lower long-term interest rates. If such a scenario occurs, the pressure on the dollar may be limited but the real question remains, how is the Fed planning to boost the employment sector?
Investors' real focus will also be on the release of the accompanying FOMC statement, where comments on the US recovery and inflation will be made. Any hawkish statements may push the dollar higher at fresh highs since. Whatever the outcome it will certainly be an interesting day to trade as a high level of volatility is expected.
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