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How to Trade the FOMC Meeting

Last updated 1/27/2010 9:07 AM ET (GMT -5) 4 Comments

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Kathy Lien

Director of Currency Research, GFT

It is that time of the month again when the Federal Reserve sits down and discusses what they want to do with U.S. monetary policy.  Their decision will impact the financing costs for everyone from corporations to the average American.  For the financial markets, the FOMC announcement is one the most potentially market moving events of the month.  Given the recent trend of weaker U.S. economic data, the Federal Reserve is faced with the tough decision of ignoring or acknowledging the acceleration in job losses and the decline in consumer spending.  Having upgraded their assessment of the economy back in December, the Fed may not want to give the impression that they are flip-flopping based upon every piece of incoming data.  Although recent data warrants a more cautious outlook by the Fed, the consequences of downgrading their assessment of the economy far outweigh the consequences of downplaying the latest reports.  If the U.S. central bank suddenly grows more pessimistic, it could exacerbate the slide in equities and trigger further risk aversion in the forex markets because traders will think that in the eyes of the Fed, the deterioration could continue.  If the statement is left unchanged and the tone of remains relatively upbeat, the dollar could rally against the Yen but the reaction in the forex markets would probably not be not as volatile.  Therefore we believe that the Fed will simply signal that the latest deterioration in data is a just a bump in road to recovery.   As usual, the 3 things investors we will be looking for tomorrow will be the tone of the FOMC statement, changes to the discount rate and any updates to their plans to end emergency programs.  We don’t expect much from the Fed since they already provided details to shut down a large portion of their liquidity programs last month.

How to Trade FOMC

Trading the Fed meeting is always difficult because in addition to a decision on rates, the tone of the FOMC statement also affects how the dollar trades.  Rather than immediately jumping into the market after the announcement, we have found that in 7 out of the last 10 times that the Federal Reserve has met, the move in the EUR/USD during the U.S. trading session continues into the Asian and London sessions.  More specifically, the dollar’s move between 2:15pm and 4pm NY time tends to follow through from 4pm to 12pm EST (noon) the following day.  The table below illustrates the reaction in the EUR/USD from 2:15 to 4pm on FOMC day and from 4pm to 12pm EST the next day.  In the 2 hours after the December FOMC meeting, the EUR/USD fell 0.07 percent and then from 4pm to 12pm the next day, it fell another 1.36 percent.  For forex traders that may not know how to interpret and trade FOMC, it may be better to wait and see how the market reacts before jumping in because the immediate reaction has a historically good chance of continuing.  

Source: FX360.com

Furthermore, the following chart illustrates the EUR/USD& #8217;s reaction following the December FOMC announcement.  As you can see, there was sharp volatility immediately after the announcement, then a brief consolidation and finally a complete meltdown in the EUR/USD.  

Source: DealBook 360

How Has the Economy Changed Since Last FOMC Meeting (December 16th)?

Finally, the table below illustrates how the U.S. economy has changed since the last Fed meeting.  Although there have been just as many areas of improvements as deterioration, the key components of the U.S. economy – consumer spending, the labor and housing markets have shown signs of weakness.  Yet the mere existence of improvements could be enough to encourage the Fed to avoid making any notable changes to their monetary policy statement.  

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Comments (4)

TurboTrader

January 27, 2010 at 10:20 AM ET

Wonderful Anaylsis Kathy! Do you forsee any posturing (that would affect outlook) by Uncle Ben due to recent political activity? Keep up the good work, I appreciate it! TT

klien

January 27, 2010 at 10:28 AM ET

Given that Bernanke's nomination has not been confirmed, it would be foolish for the Fed to do or say anything that would rattle the markets. Therefore don't expect any excess pessimism - also the other FOMC members are likely to side with the Chairman on this one to smooth his nomination. This is not a good time for division within the Fed.

milanh-fx

January 27, 2010 at 12:14 PM ET

Thanks Kathy. Keep up, please. That´s what i am looking for.
Milan

schultzz.at

January 27, 2010 at 02:24 PM ET

Fed anticipates higher levels of resource of resource utilization in the context of price stability. Hoenig dissents, saying that low level of fed funds rate no longer warranted.
Tom Schultz.

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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.