EUR/USD: Trading the FOMC Interest Rate Decision

Trading the News: Federal Open Market Committee Interest Rate Decision

What’s Expected:

Time of release: 01/25/2012 17:30 GMT, 12:30 EST

Primary Pair Impact: EURUSD

Expected: 0.25%

Previous: 0.25%

DailyFX Forecast: 0.25%

Why Is This Event Important:

Indeed, the Federal Open Market Committee is widely expected to preserve its current policy in January, but the statement accompanying the rate decision paired with the fresh batch of interest rate projections will shake up the currency market as global investors weigh the prospects for future policy. The FOMC will continue to soften its dovish tone for monetary policyas economic activity gradually gathers pace, and we should see the central bank endorse a wait-and-see approach throughout 2012 as the risk of a double-dip recession subside. However, as central bank doves Sandra Pianalto, Dennis Lockhart, and John Williams join the committee, the Fed may show an increased willingness to further shield the real economy, and members of the FOMC may talk up speculation for additional monetary support in an effort to stem the downside risks for the region.

Recent Economic Developments

The Upside

The Downside

The stickiness in price growth paired with the more robust recovery in the labor market may push the FOMC to raise its fundamental assessment for the region, and a less dovish policy statement could lead the EUR/USD to give back the advance from the previous week as market participants scale back speculation for another round of quantitative easing. However, the Fed may continue to highlight the ongoing weakness in the real economy as the slowdown in private sector consumption along with the protracted recovery in the housing market dampens the outlook for growth, and Chairman Ben Bernanke may keep the door open to expand policy further in an effort to keep the economy afloat. In turn, a highly dovish policy statement could spark a sharp selloff in the USD, and the euro-dollar may threaten the 38.2% Fibonacci retracement from the 2009 high to the 2010 low around 1.3100 as market participants increase bets for QE3.

Potential Price Targets For The Rate Decision

How To Trade This Event Risk

Trading the given event risk may not be as clear cut as some of our previous trades as the FOMC sticks to its current policy, but the statement accompanying the rate decision could pave the way for a long U.S. dollar trade should the central bank continue to soften its dovish tone for monetary policy. Therefore, if the Fed raises its fundamental assessment for the region and talks down speculation for another large-scale asset purchase program, we will need a red, five-minute candle following the event to establish a sell entry on two-lots of EUR/USD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing high or a reasonable distance from the entry, and this risk will generate our first objective. The second target will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in an effort to preserve our profits.

However, as the ongoing weakness in the real economy dampens the outlook for future growth, the FOMC may sound a bit more dovish in light of its new composition, and the rate decision may spur a bearish reaction in the USD should the central bank talk up expectations for QE3. As a result, if the Fed sees scope to expand its balance sheet further in 2012, we will carry out the same setup for a long euro-dollar as the short position mentioned above, just in the opposite direction.

Impact that the FOMC Interest Rate decision has had on USD during the last meeting

December 2011 Federal Open Market Committee Interest Rate Decision

Although the Federal Open Market Committee endorsed a zero interest rate policy ‘though mid-2013,’ the central bank continued to soften its dovish tone for monetary policy as the central bank sees the world’s largest economy ‘expanding moderately.’ As ‘strains in global financial markets continue to pose significant downside risks to the economic outlook,’ it seems as though the FOMC will keep the door open to expand monetary policy further, but the more robust recovery certainly dampens the scope for another large-scale asset purchase program as the Fed’s ballooning balance sheet comes under scrutiny. In turn, we should see the Fed continue to carry out ‘Operation Twist’ in 2012, and we may see the committee sound a bit more hawkish in the second-half of the year as the risk of a double-dip recession subside. The initial reaction to the FOMC rate decision was short-lived, with the EUR/USD falling back below 1.3050, but the reserve currency lost ground going into the end of the day as the exchange rate settled at 1.3034.

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

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