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FOMC Preview: When Will the Fed Raise Interest Rates?

Last updated 1/24/2012 3:32 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

The past few weeks have been all about Europe but on Wednesday, the market’s focus will shift to the United States where the Federal Reserve plans to implement major changes in its communication policies. These changes are aimed at increasing transparency but could end up creating more confusion than clarity. For the first time ever, the Federal Reserve will be releasing its guidance on interest rates. Currently, they pledge to keep rates at “exceptionally low levels” through mid-2013 which has translated into no rate hikes until the latter part of next year at the earliest.  Month after month, the Fed drilled their dovishness into the minds of investors and judging from Fed Fund Futures, which are not pricing in rate hikes until July 2014, they have gotten the message.  Yet the central bank still feels the need to do more and that is why they are bringing the message home by releasing their own projections on when interest rates will begin to rise. The 100 million dollar question is just how quickly the Fed plans to raise interest rates. We know that it won’t be anytime soon but it could it be very positive for the dollar if the forecasts show a rate hike in the fourth quarter of 2013. However the chance of the market underestimating the Fed’s dovishness is slim because the central bank has gone out of its way to make it crystal clear that monetary policy will remain ultra easy for the foreseeable future. In addition, there are changes to the central bank’s voting roster that leaves the FOMC with a more dovish bias in 2012. So if the majority of FOMC voters don’t see a rate hike until late 2014 or later, the dollar could weaken as investors speculate on the prospect of QE3.   Fed Presidents Evans, Fisher, Plosser and Kocherlakota will no longer be voting members of the Federal Reserve’s Open Market Committee (FOMC) this year and because of that the U.S. will be losing one high profile dove and three hawks. They will be replaced by three doves (Pianalto, Lockhart, Williams) and one hawk (Lacker), tipping the balance clearly in the favor of looser policy. 

What to Look for from the Fed?

First and foremost, it is important to know exactly what is expected and when from the Federal Reserve tomorrow. At 12:30pm, the central bank will release the FOMC Statement which be followed by their projections for the economy and the Fed Funds rate at 2:00pm ET. Then Fed Chairman Ben Bernanke will hold a press conference clarifying the central bank’s decision. For forex traders, this translates into 3 separate opportunities for volatility. 

The FOMC statement will tell us that the level of interest rates and the size of the Quantitative Program remain unchanged. It will also artfully mention the change in communication strategy without pre-announcing any projections for the Fed Funds rate. So at bare minimum the pledge to keep rates extremely low until mid-2013 will need to be replaced with language that references their new projections. At 2pm, two separate charts will be released – one will show the number of FOMC participants that project the initial increase in the Fed Funds rate in a given year out to 2016. The second chart will have dots that represent individual policymakers’ projections of where the Fed Funds rate will be at the end of each of the next several years with each dot representing one policymaker’s projection. The Fed released the templates for the charts last week and they can be found here on their website. 

What we will be looking for is the timing of the first rate hike, the number of voters who believe it will happen that year and the number of voters who do not see a rate hike until 2015 or 2016. Aside from the Fed Funds forecasts, the central bank will also release its quarterly GDP, employment and inflation projections. If the central bank reduces any of their forecasts, the dollar could suffer.  Then at 2:15pm ET, Bernanke will hold a press conference where he will attempt to calm any volatility by explaining their new procedures. He’s been loose with the tongue in the past and so we expect him to be quite frank with explaining the forecasts and how they relate to future policy.  The market is still talking about QE3 while the new communication procedures focus on rate hikes.  To avoid confusion, the press will be looking for more clarification on what this means for QE3 and what the Fed will do if economic conditions necessitate action that deviates from their longer term forecasts. 

Checking in on the U.S. Economy

With that in mind, the U.S. economy has held up well since the last monetary policy announcement. The following table shows how the economy has fared since December. Non-farm payrolls saw strong growth last month with the unemployment rate dipping to 8.5 percent. Equities rose to their highest level in months while manufacturing and service sector activity accelerated. Unfortunately a healthier labor market did not translate into stronger consumer spending. The housing market on the other hand remains weak and inflation muted. A third round of Quantitative Easing could still be needed if Europe causes more turmoil in the market. Even if the situation in Europe stabilizes, the recovery in the U.S. needs a strong jolt of momentum and the Federal Reserve may choose provide – the only question is whether they will they mention it tomorrow. 

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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.