Cautious optimism appears to be the trend for today, as forex traders and other investors consider the possibilities for tomorrow's Fed policy statement. The FOMC began its two day meeting today, and speculation is that a more positive tone could be coming.

This comes as the U.S. stock market moves slightly higher, and as the sterling and the euro gain in forex trading against the U.S. dollar. However, movements are mostly small as investors tread water, waiting for tomorrow.

GFT's Kathy Lien believes there is a good chance that the Fed will express some optimism about the economy. She makes her case in FX360:

The primary reason why we believe that the Fed could grow more optimistic is the prospect of strong job growth in March. Non-farm payrolls fell much less than the market had anticipated in February and with jobs affected by the snowstorms set to be added back this month, there is a strong possibility of positive job growth in March. The improvement in the labor market should also encourage consumer demand, particularly given the rise in retail sales for everything except for autos. There have been many areas of improvement since the January monetary policy meeting and if the Fed doesn’t want to fall behind the curve, they could choose to acknowledge the improvements tomorrow.

U.S. DOLLAR: HOW TO TRADE FED MEETING

The U.S. dollar traded higher against every major currency ahead of the Federal Reserve’s monetary policy meeting. There are a few reasons why forex traders should be nervous today, but we believe that the rally in the U.S. dollar is a reflection of the market’s hope that the Fed will come through tomorrow by growing more hawkish and optimistic.

 Equities are hovering near their yearly highs along with 2 year bond yields which indicate that the sell-off was not primarily induced by risk aversion. With some Wall Street economists calling for job growth well in excess of 150k, the Federal Reserve is under pressure to act sooner rather than later. However Fed officials do not easily buckle under pressure because they know that once something is telegraphed, it cannot be readily retracted without triggering sharp volatility across the financial markets.

The Federal Reserve has not raised interest rates since 2008, but they are in the process of gradually implementing their exit strategy. In our FOMC Preview , we wrote at length about how traders will be paying particular attention to the inclusion or deletion of the phrase “extended period” and to the number of dissenters. One of our readers also made a fantastic point about how the Fed could replace or supplement the Fed funds rate with interest paid on excess bank reserves. In early January, Fed President Lacker had openly suggested allowing more flexibility for the fed funds rate to drift higher while leaving the rate on excess reserves at 0.25 percent. We are not sure the Fed is ready to change their main policy tool but if they do, it should be perceived as a hawkish move.

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The U.S. dollar is headed higher in currency trading on the FX market as risk aversion sets in. Forex traders are a bit nervous right now as uncertainty rules the currency market today.

One of the biggest issues today is the fact that Moody's is warning that there is a chance that the credit ratings of the U.S., Britain, France and Germany may be cut. While this would normally be a problem for the U.S. dollar, the fact that Britain is in worse shape is putting pressure on the sterling. 

And, of course, there remains the problem that forex traders are far from certain that a Greek rescue package is really going to be forthcoming -- and there are questions of how effective it will be if it actually happens, limiting the the euro in forex trading.

So, for now, the U.S. dollar is expected to retain the upper hand against other major currencies, being used as a safe haven in this time of continued economic uncertainty.

Currency trading on the FX market should consider that the sterling is dropping as traders consider the latest warning from Moody's. The credit rating agency issued warnings that the U.S., U.K., France and Germany could face ratings downgrades soon with regard to their sovereign debt.

The countries that are considered most vulnerable right now are the U.S. and the U.K. And Britain is considered even more vulnerable than the U.S., reports Boris Schlossberg in FX360:

Although both Anglo-Saxon economies face serious challenges in managing their fiscal deficit problems, the UK is far more vulnerable that the US to a potential downgrade because of the relatively small size of capital markets and high dependence of its economy on the finance sector for growth.

It is little surprise that this news is resulting in a drop by the sterling in forex trading against the U.S. dollar. Added to the fact that the Bank of England might start quantitative easing again, and the fundamentals for Britain look shaky indeed.