The key to what happens at the October FOMC meeting is likely to depend on jobs. Before we take a look at what might transpire later this month, here is a quick recap of recent Fed actions:

In August the Fed surprised the market with a 50 basis point cut in the discount rate on options expirations Friday. The Fed then followed up with a surprise 50 basis point cut in the Fed Funds rate at the September meeting. The market was only expecting a quarter point cut. A tremendous rally in equities worldwide ensued.

Nothing Fundamentally Has Changed.

  • Housing is still horrendous.
  • The last jobs report was a disaster. See Moonbats Active Again in Massive Jobs Disaster.
  • Mortgage interest rates are above where they were both a year ago.
  • Interest rates are also higher than they were right before the September rate cut decision.
  • Huge numbers of ARMs reset in 2008.

So what does the future portend?

The Federal Reserve Bank of Cleveland has a Web site that shows Fed funds rate predictions. Following is a chart of October probabilities.

The above chart shows the market is expecting …

  • a 40 percent chance of a quarter point cut
  • a 40 percent chance of no move
  • a 20 percent chance of a half point cut

Looking ahead to December (click on the above link to see), multiple cuts are priced in.

Is it all so simple?

Bernanke has surprised the markets twice now. Could he surprise the markets again for the third time? The answer depends on jobs.

  1. If jobs are horrid, the market may force his hand.
  2. If jobs are just slightly weak to neutral, Bernanke just might want to send a message.
  3. If jobs are strong, there is little doubt. The Fed will go into a holding pattern and will not cut rates in October.

Now that the markets have stabilized (on the surface anyway), Bernanke is likely to find any excuse to show who is in control (using the word control loosely). Shock and Awe just might be a shock of no cut. Yes, that’s likely to upset the market, but Bernanke is going to want to steer the ship somewhere between hyperinflationary bubbles and a complete economic collapse.

With sentiment against the U.S. dollar at an extreme, an expected cut that does not happen could send the dollar soaring while sinking various anti-dollar plays such as commodities and gold. The reverse happened twice when the Fed unexpectedly cut the discount rate then the Fed Funds Rate by 50 basis points.

Bernanke has already proven the U.S. dollar is not his top concern, but it still is a concern.

The only way we learn anything about Bernanke is if jobs are slightly weak to neutral (or horrid) and Bernanke does not cut or if jobs are robust and Bernanke cuts anyway. A strong jobs report where he goes on hold, or a weak jobs report where he cuts a quarter does not tell us much. Given the bounce in the stock market, I suspect no matter how bad things are Bernanke will be reluctant to cut more than 25 basis points.

October is a weak month as far as birth/death revisions go. With that in mind, and taking into account ongoing retail weakness, mass layoffs in financials, and a continuing disaster in housing, I expect a weak to poor jobs report on Friday.

However, in light of universal extreme pessimism towards the dollar, and given Bernanke’s penchant for throwing surprise parties, those heavily short the dollar may wish to consider taking some chips off the table. Given the extreme sentiment, it’s possible the dollar rallies for a while no matter what the jobs report says or what the Fed does later on in response.

Mike Shedlock / Mish/