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Daily market newsletter: 29th June 2006   

What to expect from the Fed

There is little doubt that the FOMC will sanction another interest rate increase on Thursday, although the dollar will fall sharply if rates are not increased.

 

There is a possibility that the Fed will decide on a 0.5% rate increase and will ally this increase with a statement that rates will now be left on hold for the next 2-3 months to assess growth and inflation developments in the economy. The more likely outcome is that another 0.25% increase will be sanctioned.

 

Whatever, the decision, the FOMC statement will be watched very closely for evidence on future policy. The Fed will need to tread a very careful path to reassure markets over its inflation-fighting credentials while maintaining sufficient flexibility to take account of changing economic conditions. In particular, there will be growing risks of tightening too far given the lags associated with monetary policy.

 

Market volatility will remain a high risk after the FOMC decision, especially with markets unsure how to interpret Fed Chairman Bernanke’s statements. The net risks look to be for a slightly lower bond yields after the decision given the amount of monetary tightening priced in.

 

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