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How the Dollar Could React to FOMC

Last updated 1/24/2012 5:44 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• HOW THE USD COULD REACT TO FOMC
• EUR: STRONGER PMIS KEEPS PAIR ABOVE 1.30
• GBP: KING BACKS THE IDEA OF MORE QE
• NZD: NO CHANGES EXPECTED FROM RBNZ
• CAD: BETTER THAN EXPECTED RETAIL SALES
• AUD: LEADING INDICATORS DECLINE
• JPY: CUTS GDP FORECASTS

EXPECTATIONS FOR UPCOMING FED MEETINGS

HOW THE USD COULD REACT TO FOMC

Monetary policy announcements are one of the most important event risks for the forex markets. The reason why we follow individual pieces of economic data so closely is because of the role it plays in a central bank’s monetary policy.   However monetary policy announcements or interest rate decisions have had a diminishing impact on currencies over the past year because there haven’t been many major changes in monetary policies around the world. Having lowered interest rates to as low as they feel comfortable with and supplementing it with asset purchases, central banks are cautiously saving their final bullets. Rather than announce another round of stimulus, they have been forced to come up with more creative ways to keep conditions in their economy extremely stimulative. This leads us to the Federal Reserve who will be laying out their projections for when interest rates will be first increased on Wednesday. Their hope is that by taking away the uncertainty, they will lower volatility and convince banks to lend and businesses / consumers to borrow. Tomorrow’s rate announcement will provide many answers but also raise many questions. For currency traders, the only thing that matters is how the Fed’s announcements will impact the dollar. Going into Wednesday’s rate decision, the dollar is all over the place.  USD/JPY broke out of a tight consolidation to trade at its highest level since the beginning of the year. Although the USD also strengthened against the AUD, it weakened against the EUR, GBP, and CAD. 

There are a few things to look for in tomorrow’s FOMC rate decision:

 #1 – When are the majority of FOMC members looking for the first rate hike to occur? 

If it is before Q2 of 2014, the dollar will probably rise but if it is after 2014, the dollar will suffer

#2 – How many FOMC members expect rates to be increased for the first time in 2015 or 2016? 

And the more is NOT merrier

#3 – Did the Fed downgrade its growth, unemployment and inflation forecasts?

If the Fed leaves their forecasts unchanged, it will be neutral for the USD but if they lower their forecasts, it will be dollar negative

#4 – Is the Fed still thinking about QE3?

We do not expect the FOMC statement to mention QE3, but Bernanke will undoubtedly be asked about more stimulus in his press conference and his response may have a big impact on the greenback.

For more extensive coverage on the FOMC announcement, please read our FOMC Preview .   There are 3 opportunities for volatility tomorrow – know when they are:

12:30pm ET / 5:30 GMT – Release of FOMC Statement

2:00pm ET / 7:00 GMT – FOMC to Release Projections for the Economy and Fed Funds Rate

2:15pm ET / 7:15 GMT – Bernanke Holds Press Conference

EUR: STRONGER PMIS KEEPS PAIR ABOVE 1.30

Another day, another rollercoaster ride for the euro. Having traded as high as 1.3063 during early Europe, the EUR/USD fell sharply on reports that Greece could be downgraded to “selective default” by Standard & Poor’s. However these losses were short-lived with the EUR/USD recovering completely during the North American session to end the day comfortably above 1.30.  Unsurprisingly there was absolutely nothing to spark the rebound outside of more short covering. In fact, there has been nothing but negative news out of Europe. The Greek / IIF deal broke down completely and everyone from rating agencies to World Bank and the IMF are worried. The World Bank cut their global growth forecast to 2.5 percent in 2012 and 3.1 percent in 2013 compared to the 3.6 percent growth predicted previously for both years due largely to the Eurozone’s troubles. According to their report, the Eurozone could already be in recession and is expected to contract by 0.3 percent this year. Such grim forecasts are at odds with the latest PMI numbers that showed stronger manufacturing and service sector activity in Germany and the region as a whole. This suggests that things will only worsen for Europe, which is a view shared by many. However what we think should happen isn’t always what actually happens and this is certainly true for the EUR/USD. Everyone has pressed Europe to act quickly to avoid a Greek default and have warned of the extensive consequences that would follow if a deal is not reached but EUR/USD traders are taking the warnings in stride, bidding the EUR/USD higher at everyone opportunity. Eventually either the experts will be proved wrong or the EUR/USD will come crashing down. In the meantime, remember that fighting the tape can be frustrating. January is becoming February and now there is even talk that the new deadline will be in March. At this rate, a resolution to Greece's debt troubles may not be reached until the eleventh hour when a deal is put together haphazardly. The German IFO report is scheduled for release tomorrow and even as it may be hard to believe that business confidence can improve in the current economic environment, this is what economists are looking for. Given the sharp improvement in investor confidence as well as the increase in service and manufacturing activity, business confidence could have increased but the outlook for future economic activity will most likely worsen.   

GBP: KING BACKS THE IDEA OF MORE QE

Dovish comments from Bank of England Governor King failed to put a dent in the pound which ended the day higher against the euro and U.S. dollar. Monetary policymakers have been fairly open about their willingness to consider more stimulus which makes guessing the tone of tomorrow’s BoE minutes relatively easy. The central bank left interest rates unchanged earlier this month but with inflationary pressures easing quickly and the problems in Europe growing, more stimulus could be necessary. Governor King apparently agrees – he said today the position of Europe and the World economy is serious. Credit conditions will hamper the recovery and 2012 will be a very challenging year. As a result, the BoE stands ready to provide bank liquidity if needed to meet its inflation goal. Tomorrow’s BoE minutes will provide more clarity on the number of policymakers that share his view. Based on the dovishness of King and MPC member Posen, the central bank could increase asset purchases as soon the first quarter. The tone of the MPC will determine whether the GBP can hold onto its gains. In our opinion, the central bank will be sufficiently dovish, posing a threat to the currency’s recent rise. Aside from the BoE minutes, fourth quarter GDP numbers will be released along with the index of services and CBI industrial trends survey. For the first time in a year, the U.K. economy is expected to have contracted, which would support the case for more stimulus.

NZD: NO CHANGES EXPECTED FROM RBNZ

Today was one of the few days where economic data actually mattered to the commodity currencies. The Canadian, Australian and New Zealand dollars behaved in different ways based upon their data surprises. The CAD performed well courtesy of better than expected retail sales numbers. Consumer spending rose 0.3 percent in November against 0.2 percent expected. Although the increase was mild compared to the prior month, the consistent rise in spending was enough to keep the currency supported. The Australian dollar on the other hand suffered from a drop in leading indicators.  There have been quite a few data misses in recent weeks which explain why the market is looking for as much as 100bp of easing from the RBA this year. Consumer prices are scheduled for release this evening and any sharp downward surprises could extend the losses in AUD. The RBA cut interest rates last year and they wouldn’t have done so if CPI was hot. Also PPI, import and export prices, declined which indicates that inflationary pressures are easing in certain parts of the economy.  With no economic data on the calendar, the New Zealand dollar held steady ahead of tomorrow’s RBNZ rate announcement. Not only is the central bank expected to keep interest rates at 2.50 percent, but the tone of their statement should remain largely unchanged. Given the recent performance of the global economy, the RBNZ is not ready to roll back last year’s rate cut. With CPI falling 0.3 percent in the fourth quarter, there is very little pressure to act quickly.

JPY: CUTS GDP FORECASTS

After consolidating for the past 3 weeks, the Japanese Yen sold off aggressively against the U.S. dollar. There has been chatter about intervention but the size of the move is too small to be credited to official buying. Given that the rally occurred during the early U.S. trading session, we cannot attribute its move to the Bank of Japan’s latest actions. Last night, the BoJ left interest rates unchanged but cut their assessment of the economy. Europe’s sovereign debt troubles and a strong currency have dealt a strong blow to Japan’s recovery. The central bank now sees the economy growing by 1 to 2 percent instead of 2.2 percent this fiscal year. The growth that will carry the economy to those levels are expected to begin in the first half of fiscal 2012 (which starts in April for Japan). Although the country does not believe that it will see a current account deficit this year, they expect to miss their goal of balancing the budget by 2020 even after doubling the sales tax. Such a grim assessment begs us to wonder when the BoJ will step into the markets once again. Perhaps they are holding out to see how the situation in Europe unfolds. If growth prospects deteriorate sharply, they may have no choice but to increase stimulus. Japanese trade numbers are due for release this evening and unfortunately the country is expected to continue to run a trade deficit.  

NZD/USD: Currency in Play for Next 24 Hours

NZD/USD will be the currency pair in play for the next 24 hours. The U.S. FOMC statement will be released at 12:30pm ET / 5:30 GMT and this will be followed by Bernanke’s press conference at 2:15pm ET / 7:15 GMT. The RBNZ will release their monetary policy statement at 3:00pm ET / 20:00 GMT. 

The NZD/USD has performed extremely well this year and is currently trading in a strong uptrend, which we determine using Bollinger Bands. Having broken above the 200-day SMA at 0.8050, the next area of resistance for the pair is the October high of 0.8243. The 0.8050 level serves as support and if it is broken, 0.7855, the 100-day SMA will become the level to watch. 

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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.