FOMC Preview: What are the Possible Outcomes?

Last updated 3/17/2009 2:45 PM ET (GMT -5) 0 Comments - Add your comment

Forex Trading involves high risks, with the potential for substantial losses and is not suitable for all persons. Past performance is not necessarily indicative of future results.

Kathy Lien

Director of Currency Research, GFT

Federal Reserve monetary policy decisions have become increasingly less important after the central bank took rates interest down to a record low of 0.25 percent. With no further room to ease, tomorrow’s rate announcement could be anti-climatic, which is a big departure from the currency market’s previous obsession with the FOMC rate decisions because of the volatility that it can have on the U.S. dollar. Seven weeks have passed since the last monetary policy meeting and we are beginning to see the first signs of possible stabilization in the U.S. economy. At the same time, the Federal Reserve is running out of ammunition and each decision will need to be well timed and carefully calculated.  Although interest rates have hit rock bottom, the Federal Reserve still has the power to surprise the markets, the only question is, will they ?

There are 3 possible outcomes for Wednesday’s FOMC rate decision – the script remains the same, the central bank only increases current purchases of MBS and agency debt or they commit to buying longer term Treasuries. The option that the Fed chooses will reflect on the U.S. central bank’s degree of pro-activeness and their belief in whether more trouble lies ahead for the U.S. economy. 

Most Likely Outcome:  Script Remains the Same - Dollar Bullish

We believe that the most likely outcome for the March FOMC rate decision is a wait and see attitude from the Federal Reserve. We do not expect them to follow in the footsteps of the Bank of England who recently announced that they will begin purchasing U.K. Gilts. Despite the recent improvements in U.S. economic data, the economy remains very weak and further job losses are expected. With more than 5 million Americans out of work, the odds certainly favor more weakness than strength in the coming months. In fact, it is almost hard to believe that consumer spending has not collapsed given the severity of this recession. In order to make an intelligent decision, Bernanke may opt to wait another month to see how the economy responds to the TALF program before unveiling any new initiatives. It will be encouraging for the Federal Reserve however that the stock market is off its lows, consumer spending is holding steady and the housing market is rebounding. Easier monetary policy could still be needed but now may not be the right time for the nuclear decision of buying long term Treasuries. We expect the script to remain the same with the Federal Reserve reiterating that economic conditions warrant “exceptionally low levels of the federal funds rate for some time” and “ they stand prepared ” but make no commitment to buy longer term Treasury securities. They will also promise to use “all available tools” to stimulate the economy. This outcome should be dollar bullish because it means that the central bank does not need to immediately print more dollars to expand their purchases.

Possible Outcome:   No Commitment to Buy Treasuries but Increases Current Purchases – Mildly Dollar Bearish

A possible but less probable outcome would be if the Fed made the proactive decision to increase their current program of buying mortgage backed securities and agency debt. The recent improvements in economic data does not necessitate an immediate move and increasing the size of current purchases would be something new without being extremely groundbreaking. This should have a mildly negative impact on the U.S. dollar because it would drive yields lower on MBS and agency debt and essentially adds liquidity to the markets. 

Least Likely Outcome: Fed Decides to Start Buying U.S. Treasuries – Dollar Negative

Investors are anxiously waiting for the Fed to announce that they will start buying U.S. Treasuries, but we do not expect it to happen this time around. They have flirted with the idea but are not ready to commitment quite yet because they want to save their last bullets for another rainy day in case the slowdown in the U.S. economy exacerbates. If they do announce a concrete plan to buy longer term Treasuries, yields would fall, stocks would probably rise and the U.S. dollar would be driven lower. 

The bottom line is that the Federal Reserve is in this for the long haul and having cut interest rates aggressively over the past few months, they need to slow down and back off to see how the economy responds to all of their stimulus programs. If and only if the credit markets remain frozen and the U.S. economy refuses to improve, should they pull out their final bullets. 

Video: What to Expect from the FOMC

To give you a sense of what the Federal Reserve may be thinking, here is a snapshot of how economic data has fared since the January rate decision.

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.