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EUR/USD: Trading the Federal Open Market Committee Interest Rate Decision

EUR/USD: Trading the Federal Open Market Committee Interest Rate Decision

2010-03-15 20:02:00
David Song;Michael Wright,
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Trading the News: FOMC Interest Rate Decision

What’s Expected

Time of release:        03/16/2010 18:15 GMT, 14:15 EST
Primary Pair Impact :    EURUSD
Expected:         0.25%
Previous:         0.25%

Effect the FOMC rate decision has had over EURUSD for the past 2 meetings

03.15_TTN5

January 2010 FOMC Interest Rate Decision

The Federal Open Market Committee kept borrowing costs at 0.25% in January, and reiterated the interest rate will stay low of an “extended” period of time as the central bank aims  to encourage a sustainable recovery. However, MPC member Thomas Hoenig voted against the comment and said it was no longer be advisable to indicate that economic and financial conditions were likely to “warrant low levels of the federal funds rate for an extended period,” and added that moving to a higher funds rate would lower the risks of long-term inflation. Nevertheless, the Fed said it would need to lower its balance sheet “substantially overtime,” and pledged to start unloading its asset in the “near-future” as the central bank maintains its mandate to balance the risks for growth and inflation. 03.15_TTN2

December 2009 FOMC interest Rate Decision

The FOMC held the benchmark interest rate at 0.25% and maintained its pledge to keep borrowing costs “exceptionally low” for an “extended period” as households continue to face a weakening labor market paired with tightening credit conditions. At the same time, the Fed held an improved outlook for the economy and said that the “deterioration in the labor market is abating,” while household consumption “appears to be expanding at a moderate rate.” As the central bank expects price pressures to remain “subdued for some time,” market participants anticipate the central bank to maintain its current policy throughout the first-half of the following year as the Fed aims to balance the risks for growth and inflation. 03.15_TTN3

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario:

If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.
Bearish Scenario:

If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.
00001_EUR 00002_EUR

How To Trade This Event Risk

The Federal Open Market Committee is widely expected to hold the benchmark interest rate at 0.25% in March as the central bank aims to encourage a sustainable recovery in the world’s largest economy, but comments following the rate decision are likely to spark increased volatility in the exchange rate as Fed aims to normalize policy this year. A Bloomberg News survey shows all of the 90 economists polled forecast the MPC to hold borrowing costs at the record low, while Fed Fund futures are pricing a zero percent chance for a rate hike as policy makers pledge to keep the key rate low for an “extended” period of time. However, the board argued that it would need to lower the Fed’s balance sheet “substantially overtime,” and went onto say that the central bank will start to unload its asset in the “near-future” as they maintain their dual mandate to ensure price stability while fostering full-employment. At the same time, the Fed’s Beige Book release earlier this month said economic conditions in nine of the twelve districts improved, with household consumption increasing “slightly” in most regions, but saw “minimal” wage growth paired with “weak” demands for borrowing.

Moreover, the central bank said non-financial service-based activity were “steady or improved” for the most part, with manufacturing expanding “further,” while “hiring plans still remained generally soft.” Nevertheless, Fed Chairman Ben Bernanke expects to see a “nascent” recovery this year and argued that “a sustained recovery will depend on continued growth” in private-sector demands during his testimony in front of the House Financial Services Committee, and went onto say that “increasing incidence of long-term unemployment” remains a major area of concern as private spending remains one of the leading drivers of growth. As a result, the FOMC is likely to maintain a loose policy stance throughout the first-half of the year as households continue to face a weakening labor market paired with tightening credit conditions, but the expansion in monetary and fiscal policy is likely to support economic activity going forward as the stimulus continues to feed through the real economy. However, comments from the Fed that would reinforce the central bank’s willingness to unwind its emergency measures over the coming months is likely to spark expectations for a rate hike later this year, but dovish remarks could drag on the exchange rate as investors weigh the prospects for future policy.

Trading the FOMC rate decision is certainly not as clear cut as some of our previous trades but nevertheless, comments from the central bank could set the stage for a long U.S. dollar trade as the MPC prepares to unwind its emergency measures this year. Therefore, if the Fed holds an improved outlook for the economy and sees scope to normalize policy in the second-half of 2010, we will need to see a red, five-minute candle following the release to generate a sell entry on two-lots of EUR/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance taking volatility into account, and this risk will establish our first mark. The second objective will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its target in order to preserve our profits.

On the other hand, the ongoing weakness in the private sector paired with tightening credit conditions may lead the Fed to maintain its current policy stance going into the second-half of the year, and dovish remarks following the rate decision are likely to weigh on the exchange rate as investors scale back expectations for a rate hike this year. As a result, if we see the FOMC hold a cautious outlook for the region and reiterate borrowing costs will stay low for an “extended” period of time ,we will favor a bearish outlook for the greenback, and will utilize the same strategy for a long euro-dollar trade as  the short position laid out above, just in reverse.

03.15_TTN4

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To discuss this report contact David Song, Currency Analyst: instructor@dailyfx.com

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