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The Fed and the Inflationary Dragon

Written by A Forex View From Afar on Wednesday, July 16, 2008

Inflation; this is what happens when the Fed listens to the market and cuts 75 basis points in inter-meetings, only days before the actual FOMC get-together. Cutting rates garners inflation and we are seeing it fan the dragon’s flames right now. Inflation year-over-year reached an astonishing 5% in the U.S. and is now at the highest inflation level reached since 1992. The CPI release showed the biggest monthly gain since 1991 and the second second-largest rise since 1982.

Loose monetary policy is to blame for the current inflation levels. That, added to the fact that many of the rate cuts still haven’t reached the real economy, increase the chances that those rate cuts that we have not yet felt in the economy will further strengthen the inflationary pressures. Usually a rate decision requires anywhere from 6 to 18 months to create an impact.

Having no real growth, as the Fed Chairman reiterated in his recent speeches, leaves no open door for a rate increase any time soon and thus, inflation may still have room to rise. Second round effects appear to be very near, since the high degree of inflation experienced within the transport index right now will soon reach the other CPI sectors, like food and apparel (which are currently experiencing deflation).

Weak growth coupled with an inflationary economy does not leave any other option now for the FOMC members but to jawbone their way through the summer. That is something we have got quite used to hearing from the Fed. Fed funds futures are already pricing in a hold for the next two meeting’s outcomes; it’s now time to see if the currency market will price in the dollar’s inflation. Starting from a base of huge support at 71.50 is a great place to start.

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There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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