US Dollar Outlook Hinges Upon Federal Reserve Rate Decision Next Week - What Will They Do?

The US dollar was mixed across the majors on Friday, slipping against the euro and Japanese yen while gaining versus the British pound and commodity dollars. The US Senate’s failure to pass an auto bailout plan has left considerable uncertainty in the financial markets, especially as General Motors (GM) has already hired bankruptcy counsel. The White House subsequently stepped in on Friday morning to express disappointment about the bailout’s failure, and to say that they were considering other options, including using TARP funding in order to salvage the plan. Until the Treasury makes this official, though, the markets will likely bet on the bankruptcy of automakers like GM and Chrysler.
There was additional dollar-bearish news lingering in the markets as well, as US consumption contracted for the fifth straight month in November, highlighting the extent of the recession in the US. Indeed, the Commerce Department reported that advance retail sales fell 1.8 percent during the month, and while spending is anticipated to remain lackluster through year-end and 2009, there is a notable factor we must take into account that is skewing this report: prices. This particular index is not adjusted for inflation, and because gas costs have fallen precipitously in recent months, the Commerce Department's reading shows a 14.7 percent plunge in gasoline station sales. However, looking at the rest of the report, electronics, furniture, clothing, sporting goods, and general merchandise sales all rose slightly during November. That said, this is likely a result of heavy discounting and promotions by retailers during the holiday shopping season, which should extend through December. Once we get into the New Year, though, traders should watch these components as they will provide a good gauge as to the status of the consumer and how long the recession will last.
Overall, the news still leaves the odds in favor of an aggressive rate cut by the Federal Reserve next week. In fact, on December 16 at 14:15 ET, the Fed is widely anticipated to announce a 50bp cut to the fed funds rate, which would bring the rate to 0.50 percent. However, this is actually on the lower end of what the markets are expecting, as fed fund futures are pricing in a 72 percent chance of a 75bp cut to 0.25 percent. This upcoming monetary policy decision will be extremely important not only because of the prospect of such historically low rates, but also because the FOMC’s policy statement may signal that they are done cutting rates, or may suggest that they are prepared to pursue unconventional options like quantitative easing.