What to Expect From the Fed Decision

It’s the end of the year and Federal Reserve policymakers will meet for the last time today and tomorrow. Although in years past this central bank decision has drawn little attention, this meeting is quite the opposite. This is particularly true considering the impending Fiscal Cliff and an expiring asset purchase program. So what can we expect in tomorrow’s decision?

No Change In Interest Rates

Although Federal Reserve central bankers remain committed to lowering longer term rates and propping up employment, it is highly unlikely that rates will be moved from their current low state. Policymakers instead will shift their focus, as they have been in the past couple of years, towards asset purchases and other monetary tools to keep lending rates low and output potential high. Expect benchmark rates to remain in the target of 0.25%.

Asset Purchase Expansion

The crux of this meeting’s discussion will surround the necessity of further Treasury bond purchases. Currently, the Federal Reserve is ending its Operation Twist operations, which centered around the purchase of approximately $45 billion in treasury bonds – in an effort to keep lending rates low. But, that program ends this month. Expectations are now circling the potential for an additional lending program that would add to an already ballooning Fed balance sheet. Forecasts are for a $4 trillion balance sheet, including a likely $1.1 trillion in this latest round of easing.

What to Expect

Three likely outcomes follow tomorrow’s meeting – with all including a likely stay on rates:

No rate change, $45 billion a month in Treasury purchases. This decision wouldn’t be good for the US dollar. Although bolstering the likelihood of a recovery, an additional $45 billion a month in Treasury purchases would devalue the greenback - as monetary easing brings about a debasement of the currency. As a result, expect the EURUSD to climb higher towards 1.3100 resistance in the short term if that happens.

No rate change, more than $45 billion a month in Treasury purchases.
The effects from this decision would be worse compared to an addition of just $45 billion in purchases. As a result, given the higher rate of debasement, expectations surround the likelihood that 1.3100 could be taken out on bearish US dollar momentum.

No rate change, no increase in monthly Treasury purchases. This decision would likely support the US dollar in the short term, and could well be considered. Remember, the Federal Reserve still has about $40 billion a month in mortgage bond purchases that it is committed to through till next year. Central bankers could see this as being enough to prop up consumer spending in the foreseeable future. Expect, the EURUSD to test support at 1.2850 if this happens.
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