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FX: Stronger US Data Questions Need for Stronger Stimulus

Last updated 9/21/2011 10:42 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

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With only a few hours to go before the Federal Reserve's monetary policy announcement, the U.S. dollar is trading higher against all of the major currencies.   The rally in the greenback ahead of FOMC may be confusing to some traders but with plenty of time to discount a move by the central bank, some investors are wondering whether the Fed is setting themselves up for failure.  In the FOMC preview that we released yesterday, we discussed the central bank's options extensively along with the possible market reaction. This morning's stronger than expected existing home sales report has some investors wondering if the central bank will backpedal on their talk of more stimulus.  Do not be mistaken - there is no question that the Fed will announce a change to monetary policy this afternoon but what the existing home sales report could do is make the Fed rethink a more aggressive move.  There are many different permutations of what the Fed could announce later today - some more dovish than others and their level of aggressiveness will determine how the dollar moves.  For more - read our FOMC Preview .

In terms of this morning's U.S. economic report - existing home sales jumped 7.7 percent to 5.03 million in the month of August after falling 3.5 percent the previous month.   This was also much stronger than anyone expected and a breath of fresh air for the housing market.  For pre-FOMC traders, the strong housing market report may have triggered a reduction in short dollar positions.

 However the big question today is whether the Federal Reserve will under or overwhelm.  For anyone hoping that Bernanke will ride in like a white knight carrying a cart load of stimulus, the risk of disappointment is greater than the risk of a surprise because even the central bank has warned that their ability to stimulate the economy is limited.  With the U.S. economy experiencing zero employment and retail sales growth in the month of August, desperate times call for desperate measures.   The Federal Reserve has been preparing the market for more stimulus in some form or another since the last FOMC meeting and in doing so, they have given investors an opportunity to discount a move, which means if they want a strong and positive reaction from the markets, they need to overwhelm and not underwhelm.  Operation Twist has been talked about extensively as the Fed’s preferred way to stimulate the economy but the problem is that it has already been priced in by investors and may therefore elicit nothing more than a weak response, wasting the central bank’s efforts.  The same is true for lowering the interest rate on reserves.  Operation Twist may underwhelm the market and even trigger a buy the rumor sell the news type of reaction today.  If the Fed wants to surprise the market and trigger a sharp rally in currencies and equities, they will need to be more aggressive which means combining different options and perhaps taking an even bolder step by tying interest rates to a piece of economic data like the unemployment rate, an idea suggested by Fed President Evans. Or the Fed could announce Operation Twist and leave the door open for QE. Anything short of that though will probably end up being a big disappointment to the market and risk negative. 

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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.