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Strategy for Trading Fed Decision Goes Behind Hike or No Hike

Strategy for Trading Fed Decision Goes Behind Hike or No Hike

John Kicklighter,

Talking Points:

  • A 25 bp rate hike from the Fed is seen as a near certainty (~95-99% probability) to the market according to futures
  • This FOMC decision is one of the quarterly events that will includes updated forecasts and Yellen presser
  • While the pace of rate tightening matters, it is the potential discussion of balance sheet adjustment that is critical

Are you trading Dollar pairs? If so, the Fed rate decision today can leverage serious volatility and even determine trend for the Greenback. Sign up to watch the FOMC decision live with me on the DailyFX Webinar page.

Anxiety over complacency is rising rapidly as we head into a particularly important event risk: the FOMC's (Federal Open Market Committee) rate decision. As the central bank to the world's largest economy, financial system and pool of wealth; this gathering always carries substantial potential to move the markets. This time around, however, the threat is significantly greater than usual. This is in part due to the backdrop of the global market conditions and is more potently due to the complexities of this meeting in particular. First, the circumstances with which we have to account for in the system. Markets are extremely complacent. Risk appetite has passed its maturity phase and has moved on to gluttonous levels. This is in large part due to the calm reinforced by central banks themselves as they committed more and more capital to buffer the global economy and financial markets. Many of these groups and individuals recognize that the market has developed a dependency on this temporary support, and they are keen to transition the responsibility back onto the market. Paired with the seasonal lull we expect in the Summer (for the northern hemisphere), these are potentially dangerous waters to navigate.

For this event itself, there are a range of unique complications. The market is near certain (approximately 95 to 99 percent probability depending on how you back it out of Fed Fund futures) that the central bank is going to hike by 25 basis points to a range of 1.00 to 1.25 percent. That is already expected, so we need to move on to the unknown. Speculation of the central bank's pace of tightening into the future is more controversial and thereby rife for speculation. The Fed's last forecast for rate expectations through 2017 updated with the March SEP (Summary of Economic Projections) called for three total increases - which would suggest one more 25 bp move in the second half of the year. The market on the other hand puts the chances of a third move this year at approximately 50-50. That opens this event to surprise whether the Fed confirm its intentions to move again this year or instead throttles back. Where the widest range of speculation is open for determination though is through the potential first steps towards the inevitable stimulus reversal.

The rise of the QE (quantitative easing) program - championed by the Fed - was an unorthodox and temporary response to an extreme situation. The central banks continued to fill the system with cheap funds eventually pushing the market to a state of complacent dependence on these policy authorities to pursue risk. Eventually this accommodation will need to be reeled in (normalized), and the Fed is on track to be the first to test the waters for this as-yet unprecedented move. Given individual members' reference to this inevitability, the first steps towards defining a plan are likely to come soon. If the central bank announces its intention to start down this path, the Dollar will see its policy advantage widen even further. Yet, the greatest potential rests with general risk trends. Given the latent - if illogical - assumption that stimulus will always be there for support ('QE infinity'), seeing the outlook shift can carry enormous implications for a benchmark like S&P 500 pushing record highs despite clear value questions. As it happens, this focus may make the policy statement and Chair Yellen's press conference the most important elements of this meeting. We discuss the scenarios and importance of this rate decision in today's Strategy Video.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.