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Trading the News: Federal Open Market Committee Interest Rate Decision

Why Is This Event Important:

Beyond the interest rate decision, the economic assessment held by the central bank is likely to have a greater impact on the exchange rate, and Fed Chairman Ben Bernanke may hold a cautious outlook for the nation given the ongoing slack within the private sector.

What’s Expected:

Time of release:09/21/2010 18:15 GMT, 14:15 EST

Primary Pair Impact :EURUSD

Expected: 0.25%

Previous: 0.25%

Will This Be Market Moving (Scenarios):

The FOMC is widely expected to hold the benchmark interest rate at 0.25% in September, with market participants anticipating the central bank to maintain its pledge to keep borrowing costs close to zero for an “extended” period of time as it aims to stem the downside risks for growth and inflation. At the same time, we are likely to see MPC board member Thomas Hoenig dissent against the majority for the sixth time and push for a rate hike in order to give the central bank increased flexibility to manage monetary policy, but a growing split within the MPC could spark choppy price action in the exchange rate as interest rate expectations falter.

The Upside

The recent economic developments for the U.S. have largely been in-line with forecasts, with the private sector continue to show a mild improvement. Retail spending increased for the second month in August, with private sector employment advancing every month this year, and the data could lead the Fed to raise its economic assessment as growth prospects pick up. As a result, the central bank may drop its dovish rhetoric and see scope to normalize monetary policy going into 2011 as the economy emerges from the recession.

The Downside

However, tightening credit conditions paired with the ongoing weakness in the housing market may continue to instill a weakened outlook for the economy, which could lead the Fed to lower its assessment for the economy. Accordingly, the FOMC may turn increasingly dovish and see scope to expand monetary policy further over the coming months as it aims to encourage a sustainable recovery.

How To Trade This Event Risk

Trading the given event risk is not as clear cut as some of our previous trades as the FOMC is widely expected to maintain the expansion in monetary policy. Nevertheless, we used the policy statement to gauge the central bank’s sentiment towards future policy, and price action following the rate decision could set the stage for a long U.S. dollar trade. Therefore, if the Fed holds an improved outlook for future growth and no longer sees a need to expand monetary policy further, we will need a red, five-minute candle following the statement to establish 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 after taking market volatility into account, 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 it mark in order to preserve our profits.

In contrast, the uncertainties surrounding the economic outlook paired with cooling recovery could lead the central bank to maintain a dovish tone as it aims to stem the downside risks for the region. As a result, if the Fed keeps it pledge to hold the interest close to zero for an extended period of time and sees scope to expand monetary policy further, we will favor a bearish outlook for the greenback and implement the same setup for a long euro-dollar trade as the long position laid out above, just in reverse.

Potential Price Targets For The Release

EURUSD_Trading_the_Federal_Open_Market_Committee_Interest_Rate_Decision_body_ScreenShot011.png, EUR/USD: Trading the Federal Open Market Committee Interest Rate Decision

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

Period

Data Released

Estimate

Actual

Pips Change

(1 Hour post event )

Pips Change

(End of Day post event)

Aug 2010

08/10/2010 18:15 GMT

0.25%

0.25%

+17

+7

August 2010 Fed Interest Rate Decision

The Federal Open Market Committee held the benchmark it interest rate at 0.2% in August and pledged to hold borrowing close to zero for an “extended” period of time in order to encourage a sustainable recovery. In addition, the central bank said it will maintain the expansion in its balance sheet and will “roll over” its holdings of U.S. Treasury securities as the economic recovery cools. The Fed said that the rebound in production and employment has “slowed” during the recent months, and pledge to take the appropriate steps that would promote growth and price stability. However, MPC board member Thomas Hoenig dissented against the majority for the fifth time and saw scope to increase the benchmark interest in order to give the central bank increased freedom to managing monetary policy going forward. As the FOMC maintains a cautious outlook for the world’s largest economy, market participants speculate the central bank to maintain a loose policy stance going into 2011 in an effort to stem the downside risks for the nation.

EURUSD_Trading_the_Federal_Open_Market_Committee_Interest_Rate_Decision_body_ScreenShot001.gif, EUR/USD: Trading the Federal Open Market Committee Interest Rate Decision

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platformmay 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 EUR 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 EUR 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.

EURUSD_Trading_the_Federal_Open_Market_Committee_Interest_Rate_Decision_body_00001_EUR.jpg, EUR/USD: Trading the Federal Open Market Committee Interest Rate DecisionEURUSD_Trading_the_Federal_Open_Market_Committee_Interest_Rate_Decision_body_00002_EUR.jpg, EUR/USD: Trading the Federal Open Market Committee Interest Rate Decision

Questions? Comments? Join us in the DailyFX Forum

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