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Dollar Rallies Ahead of FOMC, but the Risks are to the Downside

Last updated 1/25/2012 10:07 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

The U.S. dollar is trading higher across the board this morning ahead of the Federal Reserve's monetary policy announcement. This price action suggests that the market is either looking for the Fed to downgrade its growth forecasts (which we believe is less likely because the USD is up against the JPY), or they believe that the Fed will not be as dovish as economists expect. In our FOMC Preview, we talked about how the benchmark for today's meeting is July 2014. According to Fed Fund futures, the first rate cut will not occur until 2 years from now and investors will be measuring the central bank's own forecasts against what is priced into the market. The rally in the dollar could gain momentum if a large number of FOMC members believe that rates will be increased before the second quarter of 2014 or earlier. If more than a few members favor the first rate hike to take place in 2015 or 2016, the dollar would suffer because it is more dovish than most people expect. We know for sure that it will be at least another a year and half before the Fed raises interest rates but they could hold off until 2014. The FOMC statement is not expected to directly mention QE3, but rest assured, the press will do their jobs and ask Bernanke whether more stimulus will be necessary at the 2:15pm press conference. With a more dovish monetary policy committee at the table this year, we expect Bernanke to hint that QE3 is still an option. Just because the Fed is releasing rate hike expectations does not mean that easier monetary policy is off the table. As indicated by today's pending home sales report, the housing market is very weak. The number of contracts for house purchases fell 3.5 percent last month with 3 out of the 4 regions in the U.S. reporting lower sales. House prices increased 1.0 percent in November according to FHFA which is encouraging but not enough to remove the overall concerns about the U.S. housing market. There have been signs of improvement in the U.S. economy but the lack of momentum could necessitate a fresh jolt of stimulus.

For more extensive coverage on the FOMC announcement, please read our FOMC Preview and our piece on How to Trade the FOMC Announcement. Here are the 3 main events to watch today:

Meanwhile across the pond, early in gains in the euro faded quickly. Business confidence in Germany improved this month but the EUR/USD failed to hold onto its initial gains as it is hard to believe that the IFO report accurately reflects the outlook for the German economy when recession remains a serious and realistic risk for the Eurozone. Reports that the ECB may have to take losses on Greek bond holdings and the EU is losing hope for a voluntary Greek bond deal reminded everyone of the macro risk in Europe. As Spanish and Italian CDS spreads moved higher, the EUR/USD moved lower. Support in the currency remains at 1.2865, which is the area where the 10 and 20-day SMA converge.

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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.