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

The U.S. Federal Open Market Committee is widely expected to hold the benchmark interest rate at 0.25% in November and is likely to maintain its $1.45T asset purchase program to encourage a sustainable recovery, and long-term expectations for higher borrowing costs could drive demands for the dollar as the world’s largest economy emerging from the worst recession since the Great Depression.

Trading the News: FOMC Interest Rate Decision

What’s Expected
Time of release:        11/04/2009 19:15 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

September 2009 FOMC Interest Rate Decision

The Federal Reserve kept the benchmark interest at 0.25% in September, but said it would slow its purchases of mortgage-backed securities and extend the deadline to the end of March 2010 “in order to promote a smooth transition.” At the same time, the board held an improved outlook for future growth and said “economic activity has picked up following its severe downturn,” and expects “a gradual return to higher levels of resource utilization in a context of price stability” as the expansion in monetary and fiscal policy works its way through the real economy. Nevertheless, the central bank noted “household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit” but nevertheless, conditions are likely to improve throughout the second-half of the year as policy makers see the economy emerging from the recession.

August 2009 FOMC interest Rate Decision

The FOMC held the key interest rate at 0.25% in August  and announced it will continue its asset purchases at a slower pace after extending the $300B program to October. The committee decided to “gradually slow” its purchases as the board aims to utilize the full amount by the end of October, and the MPC went onto say that the recent developments “suggests that economic activity is leveling out” as the government takes unprecedented steps to stimulate the ailing economy. In addition, the Fed said borrowing cost will stay “exceptionally low” for an “extended period” of time in order to foster a sustainable recovery however, the board continued to hold a caution tone as consumer spending “remains constrained by ongoing job losses, sluggish income, lower housing wealth and tight credit.” As the board sees “gradual resumption of sustainable growth,’ the MPC is likely to hold a neutral policy stance as economic activity improves.

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.

How To Trade This Event Risk

The U.S. Federal Open Market Committee is widely expected to hold the benchmark interest rate at 0.25% in November and is likely to maintain its $1.45T asset purchase program to encourage a sustainable recovery, and long-term expectations for higher borrowing costs could drive demands for the dollar as the world’s largest economy emerging from the worst recession since the Great Depression. A Bloomberg News survey shows all of the 95 economists polled forecast the Fed to hold the key rate at the record-low, with Fed Funds Implied Probability showing a 100% chance for the central bank to keep borrowing costs within a range from 0.0%-0.25%, while Credit Suisse overnight index swaps are up 80bp in November as market participants speculate the FOMC to tighten policy over the next 12-months. Meanwhile, the advanced GDP reading showed the growth rate expanded at an annual pace of 3.5% in the third quarter, with personal consumption advancing 3.4% after falling 0.9% during the three-months through June, and conditions are likely to get better over the coming months as the expansion in monetary and fiscal policy works its way through the real economy. However, a separate report showed personal spending slipped 0.5% in September, with wage growth holding flat during the same period, while the Conference Board’s consumer confidence index unexpectedly slipped to 47.7 in October from 53.4 in the previous month, and the data reinforces a dour outlook for private spending as households continue to face a weakening labor market paired with tightening credit conditions. At the same time, consumer credit tumbled 5.8% in August to mark the seventh consecutive monthly decline, with the Fed’s Beige Book stating that the labor market remain “weak or mixed” in most regions during the second-half of the year, and the slump in private spending paired with the downturn in global trade may lead firms to keep a lid on production and employment as the central bank continues to see a risk for a protracted recovery. Nevertheless, as economists forecast the annual rate of unemployment to reach 9.9% in October, which would be the highest since 1983, the Congress may continue to press on the central bank to extend its emergency programs throughout the following year, and an unexpected expansion in policy or dovish rhetoric following the meeting could weigh on the exchange rate as investors weigh the outlook for future policy. However, as risk trends continue to dictate price action in the foreign exchange market, a rise in risk aversion could send the U.S. dollar higher as the reserve currency benefits from safe-haven flows.

Trading the given event risk may not be as clear cut as some of our previous trades as market participants project the FOMC to maintain its current policy in November but nevertheless, as the central bank holds an improved outlook for future growth, price action following the meeting could set the stage for a long dollar trade. Therefore, if the Fed raises its economic outlook and sees scope to normalize policy in the following year, we will look for a red, five-minute candle following the decision to establish a sell entry on two-lots of EUR/USD. Once these conditions are met, we will set our initial stop at the nearby swing high, or a reasonable distance taking volatility into  account, and this risk will dictate our first target. Our second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in order to preserve our profits.

In contrast, the downturn in the labor market paired with ongoing turmoil in the housing and credit market may lead policy makers to hold a cautious outlook for the economy, and dovish rhetoric following the meeting is likely to weigh on the exchange rate as investors scale back expectations for higher borrowing costs in the U.S. As a result, if the Fed continues to see a risk of a protracted recovery and considers extending its emergency programs throughout the following year, we will favor a bearish outlook for the greenback and will follow the same strategy for a long euro-dollar trade as the short position mentioned above, just in reverse.

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