Q. Dear Josh, what is the market expecting from the Fed this week?

A. The market is expecting the Federal Reserve to announce a second round of quantitative easing (QE2), designed to bolster the US economic recovery. Indeed, many of the recent gains in equity markets have been caused by this belief and the hints from Fed chairman Ben Bernanke have all but convinced the market that this is going to happen on Wednesday night.

That said, there is a debate about how big QE2 could be. Last week equity markets sold off on fears that the amount may be as low as $2bn. Goldman Sachs recently stated that the total amount needed should range from $2 trillion to $4 trillion, although it added that the Fed was very unlikely to announce anything of this scale, at least for now. So Wednesday’s rate decision is likely to be more about how much the Fed chooses to inject rather than whether it will or not. In any case, expect some volatile moves in both the Dow Jones and the US dollar.

Q. Dear Josh, as an FX trader, what should I be looking out for next week?

A. FX traders are likely to be very busy next week. Not only should the Fed decision on the amount of QE2, expected to be announced on Wednesday, cause volatile moves in the US dollar, but there are also a lot of other important factors to keep an eye on. The Bank of Japan, which voted unanimously to keep rates unchanged, has brought forward its next meeting from 14-15 November to 4-5 November, which seems to be suggest it wants to be able to act on policy following the Fed’s announcement.

We also have the Bank of England rate announcement on Thursday and it will be interesting to see the Monetary Policy Committee’s reaction to the much better than expected UK third quarter GDP reading last week. And finally, on Friday we have US non-farm payrolls and unemployment rate data. It could certainly prove to be a volatile week for the forex markets.

Q. Dear Josh, how does the Volatility Index move?

A. The Volatility Index – or Vix as it is commonly known – is based on a consensus of the expected 30-day volatility of the S&P 500. It is calculated from the nearest two months of S&P 500 options and it is often referred to as a key gauge of market fear. A high Vix indicates fear and a low Vix indicates calm. At the height of the crisis in October 2008, it reached almost 90. Today it is trading in the low twenties. In general, the S&P 500 has an inverse relationship to the Vix.

You can learn more about the markets and spread betting with Josh at his free City Index seminars.