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The Federal Reserve is widely expected to hold borrowing costs at the record-low and is likely to maintain its $1.75T asset purchase program in an effort to foster a sustainable recovery, and long-term expectations for higher interest rates could drive demands for the dollar as market participants anticipate the central bank to tighten policy over the next 12 months.
Trading the News: FOMC Interest Rate Decision
Time of release: 08/12/2009 18:15 GMT, 14:15 EST
Primary Pair Impact : EURUSD
Effect the FOMC rate decision had over EURUSD for the past 2 meetings
(1 Hour post event )
(End of Day post event)
The FOMC held their benchmark rate at 0.25% which was expected despite the median forecast of 0.13% . Essentially rate are 0-.25% but the lower forecast showed that there was an expectation that we could see a dovish central bank. Indeed, the committee said that conditions are likely to warrant exceptionally low levels...for an extended period. Furthermore, the FOMC reiterated measures first announced in March, when they said they would still purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year, as well as $300 billion of Treasury securities by autumn. The subdued statement led to a temporary break from prevailing risk appetite and sunk the EURUSD over 100 pips before it regained its footing which was enough to generate a profitable short euro-dollar trade of 50 pips.
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:
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.
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 Federal Reserve is widely expected to hold borrowing costs at the record-low and is likely to maintain its $1.75T asset purchase program in an effort to foster a sustainable recovery, and long-term expectations for higher interest rates could drive demands for the dollar as market participants anticipate the central bank to tighten policy over the next 12 months. A Bloomberg News survey shows all of the 43 economists polled forecast the central bank to keep the benchmark rate at 0.25%, while Credit Suisse overnight index swaps are higher by 130bp, and the rise in the interest rate outlook could strengthen the dollar throughout the second-half of the year as the FOMC increases its growth forecast and projects GDP to expand over the next two-years. However, the Fed's Beige Book noted manufacturing remained ‘subdued' in June and July, while retail spending remained ‘sluggish,' and market participants speculate the central bank may expand its asset purchase scheme over the coming months in an effort to shore up the commercial mortgage market. A report by the Congressional Oversight Panel for TARP said smaller banks in the U.S. may need an additional $12-14B in capital ‘as the estimated losses will outstrip the projected revenue and reserves,' and the panel called upon policymakers to take addition steps to shore up the balance sheets for smaller institutions as the financial system remains fragile. Moreover, the Federal Deposit Insurance Corp. announced bank closures rose to 72 in 2009 versus 25 failures in the previous year, bringing the total cost to $16.6B year-to-day compared to $17.6B in 2008. As Fed Chairman Bernanke maintains a dovish outlook for price growth and adopts policy tools beyond the interest rate to steer the economy out of the recession, tightening credit conditions paired with the risks of a slower recovery could lead the FOMC to take additional steps to stem the downside risks for growth and inflation. As a result, the statement following the rate decision is likely to spark volatility in the currency market, and the U.S. dollar could face increased selling pressures if the central bank unexpectedly expands its asset purchase program, and limits the scope for higher interest rates in 2010.
Trading the given event risk favors a bullish outlook for the greenback as investors anticipate the Fed to maintain its current policy throughout the year, and expectations for a rate hike next year could spark a rally in the dollar as market participants speculate the central bank to tighten policy in the first half of 2010. Therefore, if the Fed keep rates on hold and retains its $1.75T asset purchase program, we will look for a red, five-minute candle following the release to confirm a sell entry on two-lots of EUR/USD. Once these conditions are met we will set our initial stop at the nearby swing or a reasonable distance taking volatility into account, and this risk will establish our first objective. Our second target 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, turmoil in the financial sector paired with fears of a slower recovery may lead the Fed to take additional steps to jump-start the ailing economy, and price action following the rate decision could set the stage for a long EUR/USD trade. As a result, if the FOMC unexpected increases the scope of its liquidity scheme or talks down the potential for a rate hike next 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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