Yesterday the Federal Reserve lowered the benchmark interest rate from 3.00% to 2.25% to help the banking institutions during the times of global financial turmoil, but will the investors expectations for the further cuts be satisfied?
The markets reacted very positively on the interest rate cut yesterday with a record breaking 4.2% growth on S&P 500 Index. Even the U.S. dollar, which usually suffers from interest rate cuts, climbed up against the euro at a fastest pace in more than a month.
While the rate has been cut by as much as 75 basis points, the FOMC statement gave some hints to the market participants that the Committee will now pay a lot more attention to the elevated inflation risks:
Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.
The reason for the dollars fast growth after the statement release can be attributed to a combination of three important factors. First, it was a huge 0.75% cut, but many investors expected an even more strong 1% cut, so the interest rate differential for the bigger than 0.75% cut might have been already included into the dollars Forex rates. Second, reducing the rate in the current situation is benefiting the U.S. economy, thus increasing the demand for the dollars. Third, FOMC signaled a possible end of the cutting cycle, while the ECB is yet to begin its cutting cycle.
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