With today being the last full trade day before FOMC, we saw more book squaring and positioning early this morning ahead of tomorrow's rate announcement and FOMC statement.

Not only do I think we saw some book squaring/profit-taking, I believe we're continuing to see euro weakness since last Tuesday's high. This correction from the 1.6000 level is not about the dollar getting strong or rallying, but it's very much about the euro showing signs of weakness in addition to a fundamental shift in the Eurozone, plus the changing tide of rhetoric coming out of the ECB.

In yesterday's update I commented about how the tide is changing with the Fed and ECB. If you missed it, you can read it here to catch up...

Fundamentally, the dollar is not gaining much ground. The news continues to be abysmal, especially in the housing and consumer sectors. But, we're seeing two key areas converge with each other -- the Fed nearing the end of the rate cut cycle and the ECB firmly in a rate hold cycle and moving towards a rate cut cycle, thus bringing a fundamental shift between the EUR and USD.

FOMC:

Tomorrow's FOMC will be watched, analyzed, dissected, and of course reacted-to by every global market, every bank, every hedge fund, and every trader (except for some techies who don't even know what FOMC stands for).

Although the reaction in our market may not be instanteous, how the Fed decides to handle rate policy this go around will likely put the market in a near-term trend at least until the next ECB rate meeting.

The rate cut cycle started about 8 months ago. According to the Fed, rates were being cut to ease pressures in the money markets, to bring down things like rising Libor rates, to stimulate growth through credit and lending, and... to save the housing market!

So far, mission failed. The housing market has yet to find a bottom, as we forecasted, and there's no light at the end of the tunnel for dropping home prices and rising home inventories and off-the-charts foreclosures. Banks are still not lending nearly to the degree they were prior to last August. Unemployment has shot up and layoffs are rampant.

The effects from the rate cuts should have already started being felt in the broader economy, but this is not the case at all. There's not nearly the turmoil in the financial and credit markets as there was last August, but I think so far the biggest benefactor to the rate cuts has been inflation, which has gone up.

My opinion is that the Fed is either at the end of the rate cut cycle as of tomorrow or is just one more FOMC away from the end. I can't call any rate hikes this year quite yet, but I do not believe Bernanke can take things much lower than 1.75% at this point.

Based on my own research and forecasting of tomorrow's FOMC, here are my probabilties:

50bps to 75bps cut: -- The probability of the FOMC cutting by 50bps is quite low. The probability of the Fed cutting by 75bps is almost non-existant, I absolutely do not see a cut of this size happening tomorrow. If the FOMC were to cut by 75bps, this would be a shock to our market and would put the dollar back under pressure and we could easily see the EUR/USD return to the 1.5900++ level. There's a decent probability we get a 50bps cut, but the likelihood of this happening is on the low end. Should the Fed deliver a 50bps cut, this too would put the dollar under some pressure, but I don't believe it would be enough to give us a topside breakout.

25bps cut: -- If the Fed does cut, I believe they cut 25bps tomorrow, that's where my highest probabilities stand. A 25bps cut really shouldn't do any damage to the dollar, maybe a slight sting, but the market will not hammer the dollar as in times past. We'll probably even see the dollar continue to recover because a 25bps cut will likely be enough of a signal to the markets to make them believe the Fed is done cutting and that we've turned the corner on the rate cut cycle.

If we do get a 25bps cut and the euro moves back north, I will continue to short the rises and I will continue to swap out my euro swing longs for euro swing shorts. Very simple...

No cut: -- Yes, a rate hold is certainly possible and I'm ready for this type of a shock. It would truly be a shock to the markets and the reaction in our market would be instantaneous and violent I believe. Fed Funds Futures does show a small probability of a rate hold, but again, this would catch the markets off guard and likely send the EUR/USD to lows we have not seen in some time.

Tomorrow:

FOMC isn't the only thing we get tomorrow... we get mega data out of the Eurozone, namely CPI, which I think will print at or below market expectations. We also get ADP Non Farm (worthless) and then we get GDP and Chicago PMI.

Based on my research, if the truth were to be told, we'd get a negative GDP print tomorrow. Not only has the economy been unable to expand, evidence is there that it has shrunk. Now I doubt we'll get a negative print on GDP, but it should print USD- nonetheless.

Although FOMC will be the most watched and reacted piece of fundamental data, we could see some volatility ahead of the decision and statement release.

EUR/USD:

Overall, I believe the brunt of the effects from the rate cuts have already been felt, absorbed, and reacted to. As you know I've been shorting the euro from the 1.5850 level and above and will continue to do so should we return back up there.

Depending on the outcome of tomorrow's FOMC it will likely determine my near-term bias for the pair. Up until last week my bias was clearly euro long but has since shifted to neutral after we made our high at the 1.6000 level.

As always, the underlying fundamentals of the market will rule the day for the EUR/USD... they always have and always will... they are beginning to shift and evolve and I will be trading them accordingly.

Best advice I can give about tomorrow is... crack open a frosty beverage and watch the chaos from the sidelines.