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FOREX: Dollar - Laying Out the Scenarios for the FOMC’s Policy Decision and Market’s Reaction

By , Chief Currency Strategist
03 November 2010 05:32 GMT
  • Dollar: Laying Out the Scenarios for the FOMC’s Policy Decision and Market’s Reaction
  • Euro Financing Troubles Temporarily Overlooked as the Greenback Takes Center Stage
  • British Pound Little Moved on Construction Activity Report, Traders Wait to Compare BoE to Fed
  • Japanese Yen Future Dimming as BoJ Minutes Show Group Expects ETF Purchases to Boost Confidence
  • Australian Dollar Carries RBA Momentum Far, Services Activity Not too Shabby Either
  • New Zealand Set for Risk Wave as well as 3Q Employment Data

Dollar: Laying Out the Scenarios for the FOMC’s Policy Decision and Market’s Reaction

The event that the markets have been waiting for is finally upon us. In less than 24 hours, the Federal Open Market Committee will wrap up its two-day meeting and announce the decisions that have been reached. Considering how investors and traders have speculated and positioned ahead of the event, the outcome would seem a foregone conclusion. If this were the case, the market’s reaction to the event would be subdued. However, that is hardly the case. The fact that the greenback tumbled so sharply and risk appetite rallied so aggressively through September and into October is testament to the level of influence this affair can actually have. Now, in the final approach, we further see the signs of a market that is preparing itself for a potential explosion of volatility and perhaps even the beginnings of a new trend. After four weeks of congestion, EURUSD has put in for a last gasp push to alleviate a rare ‘diamond’ technical pattern. What’s more, volume on the December futures euro futures contract has dropped off notably from the active levels of just a few weeks ago. And, though the S&P 500 may still hold its general bullish bias of the past two months; the pace has been more congestion than progress, volume has trended lower as the advance progressed and short interest has shown a parallel advance. The quiet before the storm.

To benchmark the market’s reaction to the FOMC’s rate decision, it is important to first asses the three general outcomes for any event: inline, better-than-expect or weaker-than-expected. The implications of this shift in monetary policy are a little more complicated than judging in such one-dimensional terms; but we will stick with it for simplicity’s sake. So, to begin, we start with the popular consensus for a second stimulus program (expansion of the current facility) to the tune of $100 billion infusions per month over a series of five to six months. Of the three scenarios, the most difficult to project in terms of market reaction is one where the Fed will offer a more expansive stimulus program than expected. This is certainly a possibility given the bias of the market and the fact that the central bank polled Primary Dealers last week (supposedly to establish expectations so as not to miss them and send capital markets into a tail spin). Here, a ‘nuclear option’ of a large one-off figure (like another $2 trillion) or larger monthly injection for an indefinite period would fulfill the scenario. For risk appetite, this could extend risk taking much further than the current market highs; but for the dollar itself, the marginal devaluation of the currency through money supply will quickly diminish. The scenario with the greatest impact potential is an outcome where the Board of Governors offers a much smaller package than what was expected or abstains all together. Most traders are familiar with the adage ‘buy the rumor, sell the news.’ This would be the case here as speculative positioning has adjusted the dollar and sentiment to a level that is consistent with a certain outcome. If that level is not met, trades will be unwound wholesale. And, finally, we have the ‘in-line’ scenario. We know the general consensus; but this does not mean that the market will not react. There is a wide degree of expectations for the outcome of this policy decision. What’s more, considering speculative interests were responsible for leveraging the capital markets and the dollar to their current position; there will be a strong desire to take profit.

As traders, we may become caught up in the volatility of the event; but it is important to remember there is a short-term and long-term reaction to the fundamental development. Short-term, we are playing against speculative benchmarks; but long-term stimulus is a temporary solution and it is exceptionally dubious when other nations are taking the exact opposite tack. And, a short aside as to the nation’s mid-term elections: the preliminary results seem to be pushing the government towards gridlock. Ultimately, the economy will sway policy, not the other way around.

Related:Discuss the Dollar in the DailyFX Forum, John’s Analyst Picks: Both the Dollar and Risk Trends offer Opportunities on Fed Decision

Euro Financing Troubles Temporarily Overlooked as the Greenback Takes Center Stage

It isn’t a stretch to suggest the euro will borrow much of its direction and volatility from the activity of the US dollar near term. However, when Fed chatter settles, perhaps the market will take note of the record highs in Irish yield spreads and reports that the ECB supposedly bought the nation’s debt. Germany is pushing hard against bond holders, which kills investor confidence for struggling periphery European economies.

British Pound Little Moved on Construction Activity Report, Traders Wait to Compare BoE to Fed

It may seem that the pound was a big mover Tuesday; but this was actually cross-market activity (euro, franc, Aussie dollar). The only data of note through the session was construction activity which hit an 8-month low. A service sector health report coming up is good for long-term growth projections; but more immediate is pricing the value of the pound by contrasting the Fed’s moves with the BoE’s decision Thursday.

Japanese Yen Future Dimming as BoJ Minutes Show Group Expects ETF Purchases to Boost Confidence

Eventually, reality will dawn on the markets; and investors will stop bidding up the Japanese yen for safe haven-, investor-, Asian region exposure-purposes. When this day comes, investors will refer to long-standing deflation, trouble stabilizing the credit market, an imbalanced economy (towards exports) and the extraordinarily liberal use of monetary policy and increase the pace of selling.

Australian Dollar Carries RBA Momentum Far, Services Activity Not too Shabby Either

The Australian dollar is still riding high off the surprise rate hike from the RBA Monday night / Tuesday morning. This isn’t necessarily that shocking considering the group’s bias. Then again, when we compare it to the Fed’s, Bank of Japan’s and Bank of England’s lean; the Aussie dollar looks even better. For this reason, this currency can be the amplified counterpart to the greenback.

New Zealand Set for Risk Wave as well as 3Q Employment Data

There is little doubt as to what trends the kiwi dollar will follow. Wherever risk trends go, this investment-currency will follow. That said, it will be interesting to note the differences in performance between this high-yield currency and the Aussie dollar. If pure investment flows pour into or out of the Aussie crosses more aggressively than the kiwi crosses; it could denote a semi-permanent shift in roles.

Tell us what you think of this article!

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ECONOMIC DATA

Next 24 Hours

Currency

GMT

Release

Survey

Previous

Comments

AUD

22:30

AiG Performance of Service Index (OCT)

45.6

Fell at fastest pace in 14 months.

GBP

0:01

BRC Shop Price Index (OCT)

1.9%

Index has been rising since Feb.

AUD

0:30

Building Approvals (MoM) (SEP)

0.0%

-4.7%

Building approvals declined in four of the past five months.

AUD

0:30

Building Approvals (YoY) (SEP)

-3.7%

4.4%

CNY

1:00

China PMI Non-Manufacturing (OCT)

61.7

Chinese manufacturing expanded at fastest pace in six months in Oct.

CNY

2:30

China HSBC PMI Services (OCT)

55.2

GBP

9:30

Purchasing Manager Index Services (OCT)

52.6

52.8

Probably below 53 for third month.

GBP

9:30

Official Reserves (Changes) (OCT)

$1935M

Reserves rose in the last 2 months.

USD

11:00

MBA Mortgage Applications (OCT 29)

3.2%

Increased in 2 of the past 3 months.

USD

11:30

Challenger Job Cuts (YoY) (OCT)

-44.1%

Job cuts fell YoY in last 16 months.

USD

12:15

ADP Employment Change (OCT)

20K

-39K

Added net 120,000 jobs this year.

USD

14:00

ISM Non-Manufacturing Composite (OCT)

53.5

53.2

Index has averaged 53.6 this year.

USD

14:00

Factory Orders (SEP)

1.6%

-0.5%

Declined in 3 of the past 4 months.

USD

14:30

DOE U.S. Crude Oil Inventories (OCT 29)

1500K

5007K

Crude inputs averaged 14.1M barrels per day last week, 171K barrels above prior week's average.

USD

14:30

DOE U.S. Gasoline Inventories (OCT 29)

0K

-4387K

USD

14:30

DOE U.S. Distillate Inventory (OCT 29)

-1000K

-1613K

USD

18:15

FOMC Rate Decision

0.25%

0.25%

Market implies no chance of hike.

USD

21:00

Domestic Vehicle Sales (OCT)

8.90M

8.82M

October total vehicle sales were the highest since August 2009.

USD

21:00

Total Vehicle Sales (OCT)

11.80M

11.73M

Currency

GMT

Upcoming Events & Speeches

USD

--:--

FOMC Meeting

SUPPORT AND RESISTANCE LEVELS

CLASSIC SUPPORT AND RESISTANCE - 18:00 GMT

Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist 2

1.4500

1.6375

89.00

1.0460

1.0922

1.0100

0.8230

127.60

146.05

Resist 1

1.4100

1.6100

86.00

0.9950

1.0750

1.0000

0.7925

120.00

140.00

Spot

1.4036

1.6023

80.69

0.9794

1.0094

0.9990

0.7718

113.25

129.28

Support 1

1.3685

1.5500

80.00

0.9500

0.9950

0.9100

0.6850

103.80

125.00

Support 2

1.3500

1.5300

75.00

0.9000

0.9700

0.8100

0.6585

100.00

119.00

CLASSIC SUPPORT AND RESISTANCE EMERGING MARKETS 18:00 GMTSCANDIES CURRENCIES 18:00 GMT

Currency

USD/MXN

USD/TRY

USD/ZAR

USD/HKD

USD/SGD

Currency

USD/SEK

USD/DKK

USD/NOK

Resist 2

14.4500

1.6755

8.7915

7.8165

1.4945

Resist 2

7.7500

5.7800

6.2750

Resist 1

13.8500

1.4865

8.3675

7.8075

1.4655

Resist 1

7.5800

5.5400

6.1150

Spot

12.2992

1.4103

6.8881

7.7513

1.2876

Spot

6.6337

5.3121

5.8392

Support 1

12.0500

1.4070

6.6950

7.7490

1.2900

Support 1

6.4500

5.3000

5.7030

Support 2

11.7200

1.3665

6.4300

7.7450

1.2500

Support 2

6.1250

5.1000

5.5200

INTRA-DAY PIVOT POINTS 18:00 GMT

Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist 2

1.4168

1.6140

81.20

1.0003

1.0195

1.0118

0.7805

114.54

130.02

Resist 1

1.4102

1.6082

80.94

0.9898

1.0145

1.0054

0.7762

113.89

129.65

Pivot

1.3992

1.6021

80.71

0.9829

1.0113

0.9960

0.7698

112.84

129.31

Support 1

1.3926

1.5963

80.45

0.9724

1.0063

0.9896

0.7655

112.19

128.94

Support 2

1.3816

1.5902

80.22

0.9655

1.0031

0.9802

0.7591

111.14

128.60

INTRA-DAY PROBABILITY BANDS 18:00 GMT

\

Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist. 3

1.4238

1.6221

81.72

0.9928

1.0221

1.0150

0.7840

114.91

131.21

Resist. 2

1.4187

1.6172

81.46

0.9895

1.0189

1.0110

0.7810

114.49

130.73

Resist. 1

1.4137

1.6122

81.20

0.9861

1.0158

1.0070

0.7779

114.08

130.24

Spot

1.4036

1.6023

80.69

0.9794

1.0094

0.9990

0.7718

113.25

129.28

Support 1

1.3935

1.5924

80.18

0.9727

1.0030

0.9910

0.7657

112.42

128.32

Support 2

1.3885

1.5874

79.92

0.9693

0.9999

0.9870

0.7626

112.01

127.83

Support 3

1.3834

1.5825

79.66

0.9660

0.9967

0.9830

0.7596

111.59

127.35

v

Written by: John Kicklighter, Currency Strategist for DailyFX.com

To receive John’s reports via email or to submit Questions or Comments about an article; email jkicklighter@dailyfx.com

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03 November 2010 05:32 GMT