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Currency Volatility Highest Since US Election: What to Watch for Fed Decision

Currency Volatility Highest Since US Election: What to Watch for Fed Decision

Justin McQueen, Analyst

USD, Fed Price Analysis & News

  • Fed Dot Plots Take Center Stage for USD Reaction
  • Currency Volatility Highest Since US Election

As I am sure many readers have noticed on DailyFX, today is Fed day. As such, there is little on the docket that will matter more than the Federal Reserve meeting tonight, which judging by FX option implied moves, is shaping up to be a volatile event. There are two key elements to watch for the meeting, which is the dot-plot projections and possible commentary on supplementary leverage ratio (SLR) exemptions.

The Federal Reserve Bank: A Forex Trader’s Guide

DOT-PLOT PROJECTIONS: The dot-plots are provided every quarter (Mar, Jun, Sep, Dec) and as it stands the current dot plots suggest there will be no rate hike until at least 2024. However, the last projections were provided back in December, and it is fair to say that a lot has changed since then. Mainly the fact that Biden managed to secure a “blue wave” after the Georgia state run-off, resulting in the Democrats being able to pass a $1.9trillion fiscal package, alongside a successful vaccine rollout. With that in mind, Fed Fund Futures are signalling for a rate liftoff in 2023.

In turn, as 4 members expect a rate hike in 2023, it would take 5 more members to shift the median projection to call for a rate hike by 2023. If indeed, this was confirmed by the dot-plots, then the expectation would be for the USD to spike higher, alongside US bond yields. However, this does challenge the current rhetoric of lower for longer from the Fed regarding average inflation targeting (AIT), while the central bank has also stressed that they remain a long way from their goals. Given that speculators have continued to cut back on USD shorts, this has increased the two way risks into the meeting, therefore, no change in median projections in interest rates is likely to lead to an equally sizeable reaction, but on the downside in the greenback, which would be accompanied by a rally in bonds, equities and gold.

Currency Volatility Highest Since US Election: What to Watch for Fed Decision

SLR: The other more esoteric part of the FOMC meeting is for possible commentary on the supplementary leverage ratio requirement. The SLR is a capital rule that requires banks to hold a minimum of 5% capital of their total assets. Last April, the Fed had exempted Treasuries and reserves from banks, which allowed them to build balance sheets by purchasing Treasuries. As such, with the capital rule expiring on March 31st, should the Fed decide not to extend the break, the view is that this could reduce bank demand for government bonds as banks would have to hold up more capital against Treasury holdings, resulting in higher bond yields and by extension, weigh on risk appetite. It is worth noting however, that while a comment may not be announced in the Fed statement, Chair Powell may well be asked about this in his press conference.

Currency Volatility Highest Since US Election

Currency Volatility Highest Since US Election: What to Watch for Fed Decision

Source: Refinitiv

Using Euro overnight implied volatility as the benchmark, currency volatility is at the highest since the US election and with a market that is arguably split on what the dot-plot projections will show, expect a sizeable reaction on either side.

FX Implied Moves and Range

Currency Volatility Highest Since US Election: What to Watch for Fed Decision

Source: Refinitiv, DailyFX

Key Fed Commentary

Currency Volatility Highest Since US Election: What to Watch for Fed Decision

Source: Federal Reserve, Refinitiv, DailyFX

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