How To Trade The Dollar On The FOMC Rate Decision

The Federal Open Market Committee’s rate decisions have quickly become the top market moving event risk for the entire currency market. No long is the central bank’s policy announcement merely a fundamental guide for the US dollar. Now the benchmark lending rate has ties to general risk trends (with an influence over the carry trade), global growth and the health of the credit market. Heading into the FOMC’s January rate decision, conditions are very different from those for the October and December meetings.


Trading the News: FOMC Rate Decision

What’s Expected
Time of release: 01/30/2008 19:15 GMT, 14:15 EST
Primary Pair Impact : GBPUSD
Expected: 3.00%
Previous: 3.50%
[B]

How To Trade This Event Risk[/B]
The Federal Open Market Committee’s rate decisions have quickly become the top market moving event risk for the entire currency market. No long is the central bank’s policy announcement merely a fundamental guide for the US dollar. Now the benchmark lending rate has ties to general risk trends (with an influence over the carry trade), global growth and the health of the credit market. Heading into the FOMC’s January rate decision, conditions are very different from those for the October and December meetings. In the last two gatherings, the market expected and the Fed delivered two consecutive quarter-point rate cuts. This steady pace of easing with a modestly dovish policy statement in tow has clearly been abandoned. Just last week, the policy group delivered a shock to traders worldwide when they announced an unscheduled and massive 75 basis point rate cut. While there was speculation that the Fed could act in response to what could have developed into a global crash in equities (the US response delayed due to a holiday), few were seriously expecting such a dramatic reduction. Now, with the board clearly prepared to take whatever steps are necessary to stave off a recession, expectations for hearty rate cuts and greater market volatility have clearly been boosted. Both economists and market participants are pricing in a half point rate cut. Beyond January’s decision though, there is clearly considerable room for speculation on how far the Fed will go.
Adding to the many different possible outcomes for the FOMC’s decision and policy statement, there is also the advanced reading for fourth quarter GDP due earlier Wednesday morning to take account of. Between these two events, there are many different possible scenarios that could play out for the dollar. However, from the many possibilities we need to chose the best combination to ensure follow through price action on a long dollar (short EURUSD) trade. Our primary concern will be the FOMC decision as there is plenty of time between the two releases, but a stronger than expected GDP release would be encouraging for a dollar long. Since the market is pricing in a 50 bp cut, we will look for either a quarter point reduction (or no change) and a statement that suggests there is an end in sight for this dovish policy regime. Given the right mix of data, we will look for a red five minute candle to confirm entry on short position in two lots with an initial stop at the nearby swing high. Our first target will equal the risk taken on the lot, and the second will be decided on discretion. To hold on to our winning trade, we will move our stop on the second lot to breakeven when the first half of the trade takes profit.
On the other hand, a major selloff on a disappointing rate decision is harder to judge. A 75 bp cut would likely be accompanied by a statement that suggests the Fed will hold off on further cuts for a while. And, a half point reduction with no end to further cuts is already heavily priced in. Therefore, our short cue will need to be very bearish; and we will follow the same strategy as above, just in reverse.

What do you expect the Fed will do? Cast your vote at our DailyFX poll.

[I]Written By: John Kicklighter, Currency Analyst for DailyFX.com

To contact John about this or other articles he has authored, email him at <[email protected]>.[/I]