Fed Grows More Upbeat and Lays Groundwork for Exit

Last updated 12/16/2009 2:56 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

The Federal Reserve has continued to lay the groundwork for unwinding their emergency programs, driving the U.S. dollar higher against all of the major currencies. Not only was the tone of the last FOMC statement of the year more upbeat, but it included a brand new paragraph detailing their plans to shut down a large portion of the alphabet soup of liquidity facilities in early 2010.  Although there was quite a bit of volatility in the forex market immediately after the FOMC announcement, traders quickly realized that even though the Fed left interest rates unchanged and reiterated that interest rates will remain exceptionally for an extended period, they are inching closer to tightening monetary policy. Their upgraded assessment of the labor market, income growth, household spending and financial market conditions reinforced the dollar bullish sentiment that has been seeping into the markets. By acknowledging the improvements in the economy and in turn downplaying the risks, the Federal Reserve has given dollar bulls the green light to charge forward. We believe that the recovery in the dollar should last for the remainder of the year. 

Going into the FOMC announcement, the market was looking for a more upbeat tone from the Fed, additional plans to unwind emergency measures and a discount rate hike. Two out three was enough satisfy dollar bulls and helps to explain why the greenback reacted positively to the statement. As usual, the devil is in the details. The central bank believes that the deterioration in the labor market is abating and that companies have shifted from laying off staff to becoming simply reluctant to hire.  They also said that income growth is modest, which is an improvement from their previous assessment that income growth was sluggish.  Last month, the Fed only said that the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010. This month, they have expanded this statement to include the expiration dates of special liquidity facilities, temporary swap agreements and asset backed securities. Given the extremely low possibility of a discount rate hike, which would have come at odds with their intention of keeping interest rates low and plans to taper off asset purchases, this is the best possible outcome that dollar bulls could have hoped for. Over the past 3 decades, the U.S. central bank has never raised interest rates before the unemployment rate peaked. If the unemployment rate peaked last month, then the Fed is on track to raise interest rates in the second half of 2010.

We highlighted the changes in the FOMC statement below (with some comments on the language). We also crossed out any sentences that were omitted from the previous statement in the current statement. Hope you find this useful!

Comparing the FOMC Statements

FOMC Statement December 16, 2009

For immediate release

Comments (1)

stewart mitchell

December 16, 2009 at 08:04 PM ET

if the dollar has strengthened, how come my gbp/usd and eur/usd that i have a short position with from yesterday are still down? eur has jus in last couple of hours weakened against usd but must be about 80 pips out with gbp/usd short?

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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.