By DailyFX – What has Changed Since the Last Meeting? The Federal Reserve's interest rate meeting scheduled for Wednesday is one of the financial… … market's biggest event risks this week.

Traders have taken the US dollar
higher going into the meeting and the Dow Jones Industrial Average slightly lower,
indicating that the market is favoring a more hawkish outcome. Interest rates are
not expected to be changed and will be left at 5.25 percent. The Federal Reserve
has not changed interest rates since June 2006. Over the past 11 months, traders
have been scrutinizing the FOMC statement for every word that has been newly
included or excluded to try to time the next movement by the Fed. Unfortunately
more than a year will pass before we actually see some action from the central bank.
This attitude has been a major contributor to the EUR/USD's move from 1.27 in June
to its present level above 1.35. Since the beginning of the year, we have seen
nothing but dollar weakness and we are finally seeing some sign of strength, but
traders have been hesitant to take the dollar much higher before hearing what the
Fed has to say. Which currency pair to trade in reaction to the FOMC statement will
depend upon how the Fed sways. A cautious statement would probably lead to more
pronounced dollar weakness against the Euro than the Japanese Yen because the market
anticipates another rate hike from the European Central Bank in June. Shorting
USD/JPY would still require paying hefty interest. An unchanged statement or one
that downplays the recent deterioration in growth to focus on the upside inflation
risks will probably lead to more dollar strength against the Yen than the Euro due
to the more beneficial carry.

US Economic Data: How Have Things Changed Since the Last Meeting?

For those who want to lay on currency trades going into the meeting, it is important
to examine how the most recent data since the last monetary policy meeting on March
20/21 stack up:

As indicated by the data tables above, growth is weaker and both the labor and
housing markets deteriorated. Inflation has been strong while service and
manufacturing sector growth have benefited from the weakness of the US dollar. The
health of the consumer has been mixed but remember the latest official spending data
is from March. Even though those numbers reflect strength, recent sales reports
from retailers such as Dress Barn, Sears Holdings, Talbots and Targets have all been
weak. This puts the Fed in a difficult place as average gasoline prices hit a
record high at a time when economic growth dropped to a 4 year low.

What Will Team Bernanke Do?

The last FOMC statement contained a number of interesting changes. The Fed
acknowledged that the economy was beginning to weaken going into the meeting but
stressed that their “predominant” concern was that inflation would fail to moderate.
In the box below, we have highlighted the major changes to the last statement.
Since then, inflation has increased due to the weakness of the dollar and rising
gasoline prices. Therefore even though we think that growth data warrants more
cautionary comments, the Fed will most likely wait for a few more weeks of data to
ensure that the deterioration in growth is continuing before they drastically change
the tune of their statement. Their next monetary policy meeting is in late June.
The tug of war between inflation and growth at the moment gives the Fed little room
to alter the FOMC statement. Team Bernanke has often put inflation ahead of growth
and for the time being, we do not expect this to change. The futures curve is not
pricing in a rate cut until the end of the year. Keeping interest rates steady and
the statement unchanged will be taken positively by the foreign exchange market,
which his could lead to a resumption of the uptrend in USD/JPY. A surprisingly
neutral or dovish statement on the other hand will send the EUR/USD back towards its
all-time highs.

Comparing the Last 2 FOMC Statements
March 21, 2007 FOMC Statement

The Federal Open Market Committee decided today to keep its target for the federal
funds rate at 5-1/4 percent.

Recent indicators have been mixed and the adjustment in the housing sector is
ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate
pace over coming quarters.

Recent readings on core inflation have been somewhat elevated. Although inflation
pressures seem likely to moderate over time, the high level of resource utilization
has the potential to sustain those pressures.

In these circumstances, the Committee's predominant policy concern remains the risk
that inflation will fail to moderate as expected. Future policy adjustments will
depend on the evolution of the outlook for both inflation and economic growth, as
implied by incoming information.

Jan 31, 2007 FOMC Statement

The Federal Open Market Committee decided today to keep its target for the federal
funds rate at 5-1/4 percent.

Recent indicators have suggested somewhat firmer economic growth, and some tentative
signs of stabilization have appeared in the housing market. Overall, the economy
seems likely to expand at a moderate pace over coming quarters.
Readings on core inflation have improved modestly in recent months, and inflation
pressures seem likely to moderate over time. However, the high level of resource
utilization has the potential to sustain inflation pressures.
The Committee judges that some inflation risks remain. The extent and timing of any
additional firming that may be needed to address these risks will depend on the
evolution of the outlook for both inflation and economic growth, as implied by
incoming information.

Kindest Regards,

Kathy Lien
Chief Strategist
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: klien@fxcm.com

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DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com