All Trade Ideas and trading scenarios found on FX360.com are hypothetical. FX360.com has not placed these Ideas in a live trading environment. Forex Trading involves high risks, with the potential for substantial losses that exceed your initial deposit and is not suitable for all persons. Past performance is not necessarily indicative of futures results.

How to Trade the Fed Rate Announcement

Last updated 11/1/2011 4:40 PM ET (GMT -5) 2 Comments

• Share this:

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• HOW TO TRADE THE FED RATE DECISION
• EUR: 500 PIPS IN 48 HOURS
• GBP: FASTER GROWTH NOT EXPECTED TO BE SUSTAINED
• AUD: RBA CUTS RATES
• CAD: OIL PRICES DOWN, GOLD UNCHANGED
• NZD: EMPLOYMENT NUMBERS ON TAP
• JPY: RISK AVERSION DRIVES YEN HIGHER

EXPECTATIONS FOR UPCOMING FED MEETINGS

HOW TO TRADE THE FED RATE DECISION

Central bank rate decisions are one of the most important event risks for the forex market. In the case of the Federal Reserve, the potential market impact of the interest rate decision on currencies is magnified by the possibility of a change in monetary policy and the importance of the U.S. dollar. However the rally in the greenback and the sell-off in equities indicate that investors are focused on one thing and one thing only, which is the uncertainty in the global economy. What this means is that if the Federal Reserve eases monetary policy because they have grown more pessimistic about the outlook for the U.S. economy, it may not be as overwhelmingly negative for the dollar as most people would normally expect. It may cause the dollar to sell off initially but the selloff may not last in any other pair outside of USD/JPY if the Fed is pessimistic enough to drive risk appetite even lower. The central bank will be releasing its latest staff forecasts and sharp downward revisions to GDP growth for 2011, 2012 and 2013 will not be received warmly by the market. As a result, it is perfectly feasible and probably likely that the dollar will rise against risk currencies if the Fed takes additional steps to ease monetary policy.  

There is no room to lower interest rates in the U.S., but the Federal Reserve could increase the size of their asset purchase program or change their communications strategy. Recent comments from Fed officials suggest that they are warming to the idea of more stimulus but their next move could be another middle of the road approach as they reserve QE3 for a time when the markets are down 20 and not 5 percent. 

When it comes to changing their communication policy, the Fed has a few options:

1.      Release Economic Forecasts and Forecasts for Fed Policy

2.      Set Inflation Target

3.      Pledge to Keep Rates Low Until Unemployment Falls below a Certain Rate

There is a great deal of urgency within the central bank to increase transparency on monetary policy but it is a challenge to establish and agree on specific targets and could cause confusion about the central bank’s longer term objectives. Nonetheless, this approach is still the Fed’s preferred option over expanding the balance sheet. The central bank has already pledged to keep interest rates at exceptionally low levels through mid 2013. If they choose to extend this period, which would be a new forecast for Fed policy, it would hurt USD/JPY but probably not as much as a target for inflation or the unemployment rate. A more aggressive approach would be the one that Chicago Fed President Evans has suggested which is to officially say that rates will remain at extremely low levels until the unemployment rate falls below 7 percent or inflation rises above 3 percent.  Explicit unemployment and inflation targets would be almost as bearish for the U.S. dollar as QE3. The Fed could also bite the bullet and expand their balance sheet (QE3) which would send the greenback sharply lower but the chance of it happening this week is slim. The FOMC announcement will be made at 12:30pm ET and this will be followed by a press conference by Bernanke at 2:15pm ET.  Expect volatility to pick up around both of these events.

EUR: 500 PIPS IN 48 HOURS

Over the past 48 hours, the euro has fallen nearly 500 pips. Weaker economic data from the U.S. and China along with concerns about the referendum in Greece has driven investors out of risky currencies.  The pressure is on for the European Central Bank to temper the market’s volatility, making Mario Draghi’s first monetary policy decision as ECB President extremely difficult. The widening of Italian-German and French-German 10 year yield spreads shows how serious the concerns have become. Both Italian-German and French-German 10 yr yields spreads have widened to record levels, meaning that investors believe the risk of investing in Italian or French bonds versus German bonds, which are considered the safest fixed income investments in the Eurozone is higher than where it was back in October, when Greece was at the brink of default. By deciding to hold a vote on the EU debt deal, the Greeks have erased months of hard work by EU leaders and restored the market's fears about contagion for Italy and France. This makes this week's G20 meeting all that more eventful. Originally, the G20 Summit was expected to be a nonevent with the EU debt bringing stability to the markets - now that uncertainty is once again at escalated levels, the G20 may be forced to offer support to the markets verbally or physically. We have already seen evidence of central bank officials succumbing to the pressure of European uncertainty. The Reserve Bank of Australia cut interest rates by 25bp last night and even though they attributed the cut to the prospect of lower inflation, we are certain that the volatility in the markets have played a role, with the RBA feeling compelled to take an insurance cut. Thousands of investors in Australia have been affected by the destruction of MF Global and the rate cut will help ease some tensions in the local banking sector. The return of volatility could also encourage the European Central Bank and the Federal Reserve to take similar measures to ward off recession. German unemployment numbers are scheduled for release tomorrow and unfortunately we expect job losses to grow. The Swiss Franc also weakened against the U.S. dollar as manufacturing activity in Switzerland contracted for the second month in a row –a consequence of a strong currency and weaker Eurozone economic activity.

GBP: FASTER GROWTH NOT EXPECTED TO BE SUSTAINED

The British pound strengthened against the euro and weakened against the U.S. dollar today. A slew of economic releases came out of the U.K. this morning including the nationwide house price index, manufacturing purchasing managers’ index, preliminary GDP numbers, and the index of services. GDP figures showed that U.K. third quarter growth rebounded. The economy grew faster than expected as GDP rose 0.5 percent from the second quarter, when it increased 0.1 percent. The market had forecasted 0.3 percent growth. With the increase in GDP partly due to one-time factors, Bank of England Markets Director Paul Fisher has said the pace may not be sustained and there’s a chance of stagnation in the current quarter. Economic activity is fading quickly as today’s manufacturing PMI number shows. The index of purchasing managers’ fell to 47.4 in October from 50.8 in September. The index came in lower than the expected 50.0 and could possibly point to contraction in the fourth quarter. U.K house prices edged up in October according to Nationwide, lifting annual house price growth into positive territory for the first time in six months. House prices increased by 0.4 percent, versus the 0.1 forecast, in October after increasing 0.1 percent in September. Prices are 0.8 percent higher than a year ago. There still exists a challenging economic backdrop in the U.K. and fundamentally the housing market is still treading water. Property transaction levels remain subdued, and prices essentially flat compared to last year. The economic outlook remains uncertain and the recovery is expected to remain sluggish keeping downward pressure on house price growth going forward. The index of services in the U.K. increased modestly at 0.4 percent in August and July’s reading was downwardly revised to 0.8 percent. Each of the four main service sector components increased compared with the same month a year ago. Construction PMI is due for release tomorrow and a reading below 50 would reinforce concerns about the UK economy. 

AUD: RBA CUTS RATES

The Australian, New Zealand and Canadian dollars continued to sell-off against the greenback. The big story last night was the Reserve Bank’s decision to cut interest rates. Based upon the monetary policy statement, the rate cut appears to be one off but some economists argue that the central bank rarely makes one off moves and that this could be the beginning of more easing. Future decisions will depend largely on Europe because if the debt crisis stabilizes, the RBA may not be as concerned about the outlook for the Australian economy.  Economic data has not been horrid - in fact the manufacturing PMI index increased in October. Our colleague Boris Schlossberg covered this thoroughly – “In Australia, the RBA as expected lowered its benchmark rate by 25bp to 4.5% noting that, “recent information is consistent with a moderation in the pace of global growth, though fears of a major downturn have not been borne out so far. “The move to a more neutral posture should be a welcome sign to the country’s retail and housing sectors. Housing prices have dropped for 3 consecutive quarters amidst slowing demand and decline in consumer confidence. Today’s action will likely result in lower service costs for many Australian homeowners where the majority of mortgages are variable rate. The news could provide a small boost to growth going into the key Christmas season.   As we noted earlier, “The Aussie remains the predominant carry trade currency in the G-20 universe, but with today’s action the RBA has clearly reversed course on interest rate policy going forward. Given its massive interest rate differential versus the other majors, the Aussie will continue to remain closely tied to risk appetite for the foreseeable future, but it may lose some of its luster if RBA lowers rates further into the end of the year and beyond. “ New Zealand employment numbers will be released tomorrow afternoon and the hawkishness of the RBNZ suggests that the labor market could be doing better. 

JPY: RISK AVERSION DRIVES YEN HIGHER

The Japanese yen strengthened against all the major currencies with the exception of the U.S. dollar as investors grew jittery over Greece’s announcement to hold a referendum on its proposed bailout package. The Bank of Japan released the minutes of the Monetary Policy meeting held on October 6 and 7. Overall, the tone seems optimistic as officials recount positive economic developments, especially in the production and exports, private consumption, and housing investment areas. The employment and income situation continues to be severe, although there have been some signs of improvement. Overall, reconstruction efforts are moving forward and Japan is on its way to a sustained economic recovery.  Japanese wage earners’ total cash earnings in September were unchanged from the same month a year earlier, labour ministry data showed today. It is a sign that wages could be stabilizing after the recent decline. Nomura Holdings Inc., Japan’s largest brokerage, said it will consider eliminating jobs at home as part of a plan to triple cost cuts to $1.2 billion following its first quarterly loss in more than two years. While most of the expense reductions will be in Europe, the company will also be targeting Japan. The Bank of Japan is also enduring losses – on its security purchases designed to provide stimulus. The central bank has lost as much as 22.4 billion yen ($281.7 million) purchasing exchange-traded funds as the Topix Index approaches a 27-year low. The central bank’s stock holdings have declined about 4 percent since buying began on December 15, 2010, according to estimates that used government filings. The purchases are part of a 20 trillion yen BOJ plan to stimulate economic growth and boost investor confidence by buying securities, such as government debt, commercial paper and real estate investment trusts. The central bank expanded the program last week by 5 trillion yen after the country’s currency reached a post-war record against the dollar, threatening the export-driven economy. To combat the strong yen, Japan’s government signaled it is prepared for sustained intervention to ward off speculators. The strong yen has already forced companies from Panasonic Corp. to Honda Motor Co. to lower earnings forecasts and announce plant closures. Finance Minister Jun Azumi said in Tokyo he will “continue to intervene until I am satisfied,” after yen sales yesterday caused the largest slump in the currency since 2008. The intervention was the first since August, when Japan spent 4.51 trillion yen ($57 billion) seeking to stem the currency’s surge. Unilateral currency intervention is rarely successful which hints that the BOJ may return to the foreign exchange market to quell any further strengthening of the yen.

EUR/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours will be EUR/USD. We expect from Germany their unemployment change, PMI manufacturing index, and unemployment rate, all for the month of October at 4:55 AM ET / 8:55 GMT. The Eurozone will release its PMI manufacturing index for the month of October at 5:00 AM ET / 9:00 GMT. From the U.S., we expect MBA mortgage applications and Challenger job cuts for the month of October at 7:00 AM ET / 11:00 GMT and 7:30 AM ET / 11:30 GMT, respectively. We also expect ADP employment change for October at 8:15 AM ET / 12:15 GMT. Most importantly we expect the Fed’s rate decision at 12:30 PM ET / 16:30 GMT. Following the U.S. rate decision, Dr. Bernanke will hold a Fed press conference at 2:15 PM ET / 18:15 GMT. 

EUR/USD has been extremely volatile lately due to the announcement of a proposed debt deal and Prime Minister Papandreou calling a referendum on it. Currently, our Double Bollinger Bands indicate the pair to be range bound. Nearest support is at today’s low of 1.3607. Should the pair continue to fall, significant support will be found at 1.3552, where the lower first Bollinger band lies. To the upside, nearest resistance is at 1.3817 as indicated by the 50-day SMA. If the pair breaks out from this price, heavy resistance will be found at 1.3980, where the upper first Bollinger band lies.

The information, including Commentary and Trade Ideas, provided on FX360.com should not be relied upon as a substitute for extensive independent research which should be performed before making your investment decisions. Global Forex Trading and FX360 .com is merely providing this information for your general information. The information and opinions presented do not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision and should tailor the trade size and leverage of their trading to their personal risk appetite. Any projections or views of the market provided by FX360.com may not prove to be accurate.

The views of the authors and analysts are not necessarily those of Global Forex Trading, its owners, officers, agents or other employees. FX360.com and the currency research team will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained on FX360.com. Global Forex Trading and the currency research team do not render investment, legal, accounting, tax, or other professional advice. If investment, legal, tax, or other expert assistance is required, the services of a competent professional should be sought.

• Share this:

Comments (2)

InvTraKS

November 02, 2011 at 08:49 AM ET

Love the way you correlation events and how it will affect our trading. Hoping to read your book solely on inter-markets and how it will affected forex trading.
invtraks.blogspot.com

Darkdoji

November 02, 2011 at 03:07 PM ET

End of presser - QE3 still in focus, FED remains accommodating.

Add Your Comment

Please login to post a comment or sign up for an FX360® account.

Loading...

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.