FOMC Preview: 3 Questions for the Fed

Last updated 9/22/2009 2:04 PM ET (GMT -5) 5 Comments

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Kathy Lien

Director of Currency Research, GFT

The countdown to the FOMC meeting has begun.  The Federal Reserve is set to announce their monetary policy decision on Wednesday afternoon at 2:15pm ET.  U.S. interest rates have been sitting at a record low level of 0.25 percent since December 2008 and tomorrow the central bank is expected to keep them there.  However that does not mean that there will be no volatility tomorrow – quite the contrary considering that the currency and equity markets are consolidating in the anticipation of fresh revelations from the FOMC.  The dollar has sold off this morning but the sustainability of the greenback’s weakness rests entirely on the outcome of the Fed meeting.  With fed fund futures pricing in a rate hike in the first half of next year, the market will be looking for some positive reinforcement from Team Bernanke.  In the best case scenario, the Fed will upgrade their assessment of the economy, taper off their mortgage backed securities asset purchase program and remind the markets that they are working on an exit strategy. At the same time, the Fed is not in a rush to raise interest rates and therefore the fed funds rate will remain “exceptionally low” for “an extended period of time.”  If the tone of tomorrow’s FOMC statement is more upbeat, it should be initially positive for the dollar. 

There are 3 important questions that the market wants the Federal Reserve to answer tomorrow:

1)    Does Recent Improvements in Economic Data Warrant More Optimism?

2)    Will the Mortgage Backed Securities Asset Purchase Program be Tapered Off?

3)    Is it Time to Talk about Exit Strategies?

At the last FOMC meeting in August, optimistic comments from the Federal Reserve and the not so subtle hints that the central bank is thinking about an exit strategy drove the dollar higher across all board.  The U.S. central bank recognized the improvements in the economy by saying that “economic activity is leveling out” and also put a time stamp on when they plan on ending Treasury purchases.   The Fed satisfied the market by recognizing the improvements in the U.S. economy and the financial markets.  The central bank’s decision to leave their $300 billion Treasury purchase program intact and to complete it in October suggests that they do not feel that the U.S. economy needs additional stimulus at this time.  Based upon the tone of the FOMC statement, the Federal was more optimistic but the statement still contained some cautiousness as spending is being constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.  

Developments Since the Last FOMC Meeting

However last week, Fed Chairman Ben Bernanke declared that the recession is “very likely over.”  Bernanke would not have made these comments lightly unless he really believed in it but in this type of market environment, it always pays for the Fed to be more cautious to avoid fueling excess optimism. The stabilization of the financial markets should drive the Fed to pare their mortgage backed securities asset purchase program in the same ways as the Treasury purchase program last month.  This means that the size of the program will remain unchanged but the Fed will be slowing the pace of purchases.  

Since the last FOMC meeting, economic conditions have improved for the consumer, housing market, manufacturing and services sector, and maybe most importantly, the equity markets. Since nearly all the concern surrounding whether a recovery will be sustainable is rooted in spending, this month’s sharp rise in consumer spending certainly increase the chances of the U.S. economy pulling out of the storm. One may argue that the cash for clunkers program was a primary driver behind consumer demand and will cease to help in coming months now that stimulus has been unwound. However, when removing autos from the equation, sales still performed impressively indicating that the consumer may have finally gotten the jump-start they needed. The Housing market is another area of concern that is slowly but surely regaining positive momentum. Despite the fact that Pending Sales have eased, Existing Home Sales doubled last month. On the services front, ISM Non-Manufacturing was higher by 2 points, but is still unable to move above 50. Manufacturing ISM adds to the life behind the manufacturing sector, and finally succeeds at pushing above the 50 level. Regardless of all the gains made on individual economic data, none are more indicative of optimism than how equities have performed since the Fed’s August meeting. The Dow Jones index hit a year to date high in what is typically dubbed the worst month for stocks – September. However, the possibility of a correction still looms, as similar gains have been seen in the middle of some of the worst recessions the country has experienced.  Aside from the promise that stock markets have provided, the usual suspects are still a threat to the economy. Chief among these are the labor markets. Although the number of people claiming unemployment benefits is falling, the unemployment rate is creeping closer to 10%. If we do not see substantial improvement on this front, it is unlikely that spending will be able to persist. Luckily, this is the worst that the last month had to offer and because of that, t he risk for the dollar is to the upside as we expect the Fed to recognize the improvements.   This is particularly true if they replace the phrase “economic activity is likely to remain weak for a time” with something more moderate.

What to Expect for the Dollar

Since we expect the Federal Reserve to grow more optimistic, the best indicator of how the dollar could react to the FOMC announcement is last month’s price action.  At the time, the Fed was also more upbeat and tapered off their Treasury Purchase program.  At the time, the dollar surged against both the euro and Japanese Yen, but quickly recovered its gains as risk appetite swept over the market, lifting equities and currencies in the process.  The following charts illustrate how the EUR/USD and USD/JPYreacted to last month’s FOMC announcement.  The table below the charts compares how economic data has changed from the last meeting.

EUR/USD 5 Minute Chart

USD/JPY 5 Minute Chart

Comments (5)

Hari

September 22, 2009 at 02:27 PM ET

Hi Kathy,
What strategy should be adopted for trading this FOMC news.
Rgds

spunky

September 23, 2009 at 10:01 AM ET

Here is what I do , I use GFT 3 minute charts. I look just to the 3 or 4 candles prior. I hope to see a steady price action. If the candle is green prior to annoucement , I go long, but with a very tight stop 12 pips and big limit like 40 pip, reverse this for a red candle. Be quik, move your stop up to profit if PA doesnt hit the 40 pips, manage this trade; then you can change you stop and limit and play the retrace using your BB . I will kinda martingale at the top of the price action of the initial candle, if it is a big suprise you should trigger your limit, you will be playing the 4 or 5th candle

I know Kathy doesnt do this, and waits for the big retrace and a general overall direction to emerge post release.


Good luck to all today

I bet Helicopter Ben- talks up the buck abit and we see a nice spike aganist the euro

JMHO

Liverpinguin

September 23, 2009 at 11:31 AM ET

Hello Spunky,
why do you look 3 or 4 candles prior?, is there any speculative movement minutes before the announcement?, even if someone would get privilege information or their macroeconomic prediction is accurate, to take any position before the announcement is too risky, if you take a look to the historical movements there has been most of the times retracements to the first movement, apart from that the Requotes from brokers make very difficult to adjust stops and limits.
Your strategy of 12 pips Stop and 40 pips profit prior to announcement is too risky for me.

On the other hand, I think you are right I would bet that we will see a nice spike against the Euro.

Good luck tonigh.

Mohamed Makarati

September 22, 2009 at 04:39 PM ET

Hi Kathy My name Is Mohamed Makarati adn I want ask you about FOMC when the price start movinge before announce the resulte before 15 min or when and any way if the Fed change or still the same rate it will be postive for USD and what about supprt are 1.4755 tomorow may will brackout can you help me please

spunky

September 23, 2009 at 02:27 PM ET

Geeze gotta pat myself on the back here ; }

2 good calls on the 3 minute pre release candles, last 2 days RNZB, and FOMC

Thought team Ben would talk up the exit strategy more( dollar positive ) , oh well

Trade what you see ; took my pippage

regards
Brad

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.