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Dollar Trader Preparation and Strategy for an Expected Fed Hike

Dollar Trader Preparation and Strategy for an Expected Fed Hike

John Kicklighter, Chief Strategist

Talking Points:

  • After wrapping its two-day policy meeting, the FOMC will announce its decision on the benchmark rate and update forecasts for 2017-2019 at 19:00 GMT
  • The market has priced in a 100 percent probability that the Fed will hike by 25bps through Fed Funds futures, marking a skew in certain outcomes' impact
  • While this event will influence the entire financial system, the EUR/USD and USD/JPY may prove the best options to respond to a range of scenarios

Sign up for the live FOMC rate decision coverage Wednesday and see what other live coverage is scheduled to cover key event risk for the FX and capital markets on the DailyFX Webinar Calendar.

Today's FOMC rate decision is a loaded event risk whose influence can stretch well beyond the US Dollar, US equities and Treasuries. As the world's largest central bank helming the world's largest economy, the policy that this group enacts can lead to global shifts such as the global market recovery from the Great Financial Crisis (first half 2009), the Emerging Market Taper Tantrum (June 2013) and the S&P 500's loss of deep speculative momentum (2015). Yet, beyond the innate potential of this event; we are seeing a confluence of speculative fear and assumption that will amplify short-term volatility in some corners of the market and redefine underlying trends in others. The chase for yield has charged far beyond a state of excess to increase speculative reactivity. Meanwhile, the markets reflect certainty for a tightening that has not only stretched assumed value on certain markets but further leveraged the disparity in structurally-important global monetary policy. Traders and investors would do well to tune into this event.

The December Fed meeting is what is considered a 'quarterly' event in which the typical rate decision and monetary policy statement are bolstered by the group's forecasts and Chairwoman Janet Yellen's press conference. This more intensive feedback comes amid a dramatic increase in speculative positioning. Heading into this decision, the market has fully priced - via Fed Fund futures - a 25 basis point hike to the range. While the central bank has long attempted to warm the market to the possibility of a follow up hike to the initial 'lift off' in December 2015, skepticism has undercut their efforts up until recently. Certainty of a hike this month has further charged speculative frenzy that has spilled over to future assumptions. This in turn has generated clear conclusions for US monetary policy which can significantly curb the impact of what would traditionally be considered a 'hawkish' move and charge a more reserved outcome.

Breaking down the variable elements of this event risk, the rate decision itself is fully accounted for such that a hike will not charge the Dollar or throttle risk trends; but a decision to hold would lead to dramatic response from both currency and speculative assets (likely bearish). The real debate for the event is focused on the pace of further tightening into 2017 and beyond. While futures are not fully pricing in the 50 basis points worth of hikes the FOMC projected in the September update (halving the June outlook), there is a degree of hawkish expectation for the curve. A reduction in additional tightening next year would be considered dovish and there by Dollar bearish. Even a hold of the 2017 forecast at 50bps could be treated as a 'disappointment'. To significantly leverage an already buoyant Dollar amid these assumption is difficult to achieve - though not impossible. For risk trends borrowing from the enthusiasm of the S&P 500's and Dow's charge to record high, it is difficult to imagine any scenario that truly contributes to the rampant speculation. We discuss the importance of this event, the critical components, various scenarios and tapped-in instruments in today's Strategy Video.

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