How To Trade The FOMC Rate Decision

[B]Trading the News: FOMC Rate Decision[/B]
[B][U]What is Expected[/U][/B]
Time of release: [B]09/18/2007 18:15 GMT, 14:15 EST[/B]
Primary Pair Impact : [B]EURUSD[/B]
Expected: [B]5.00%
[/B]Previous: 5.25%

[B]How To Trade This Event Risk[/B]
Though the Federal Reserve’s Board of Governors have left the Federal Funds rate unchanged for more than a year now, price action after each 18:15 GMT release has shown some life. This is important to note as it gives some feeling for the fundamental potential the announcement holds for the dollar, whether there is a substantial change or not. However, a modest reaction is the most unlikely outcome for the September 18th meeting. In the past month, speculation that the Fed was preparing to cut has reached a fever pitch. Until August 17th, those forecasting a drop in the benchmark rate occupied a very small minority. Then, as a credit contagion was clearly spreading beyond the housing markets boarders, the policy authority released an unscheduled statement to assure market participants and consumers that they were monitoring the situation. More importantly, this announcement came along with a 50bp cut to the discount rate (the rate at which banks may borrow from the Fed). From that point on, the question was no longer whether the central bank would cut or not, but to what extent they would reduce the overnight rate by - 25 or 50 basis points. A firm majority sees the cautious Fed setting the rate at 5.00 percent. Conversely, any change in the discount rate or a clear direction coming out of the commentary could rouse the dollar.
Considering the heavy bias for Tuesday’s Fed policy decision, a rate cut may actually be an event to rally around. Just recently, futures markets have shown that expectations for a 50 basis point cut are greater than those for 25 basis points. Therefore, should the Fed go for a mere quarter point loosening, the dollar could rally as prepositioned pessimists are forced to adjust their positions. However, the headline rate change is not the only matter of interest in this event risk. For a dollar-positive reaction, the Fed should not alter the discount rate nor can their policy statement clear the way for a string of unfettered rate cuts. If the fundamentals line up and the five minute candle following the release close red, a short trade would be triggered. Taking two lots, the short would find an initial stop at the nearby swing high (or a reasonable, fixed distance) with a first target equal to risk and second based on discretion. Upon making the first target set the stop to B/E.
The market’s forecast for the Board of Governor’s decision is clearly dovish. Though the majority of the market is forecasting a 50 basis point cut, should the Fed actually change the overnight lending rate by that severity, it would still drive the dollar lower. However, if the trimming isn’t as extensive as that, the bears could still reign should the policy group clearly open the door to further cuts this year.