Forex Analysis (Tue August 10, 2010 2:15pm EDT NY Time) US Federal Funds Rate...

Henry Liu

Former FPA Special Consultant
Messages
473
FOMC is going to release its short-term interest rate decision today and most analysts agree that FOMC will keep current rates unchanged especially after the series of worse than expected economic data during the past few weeks, including the disappointing NFP (Nonfarm Payroll) Employment last Friday.



However, even though there is no chance for a surprise rate change, as predicted by the chart above, (0.0%~0.25% is about 100% probability) the real focus is still on the FOMC statements on future monetary policy.

The Market
With US economy facing significant possibilities for double dip recession, speculation has been growing that the Fed is likely to announce a second round of debt purchases, or quantitative easing, in a attempt to stimulate the economy. This sentiment has been echoed by St. Louis Fed. James Bullard in his recent article...

Fed. Chairman recently stated that the Federal Reserve currently has three options:

1. Strengthening commitment to keep interest rates low.
2. Lowering the rate it pays on bank reserves
3. Expanding Fed Balance Sheet...

If FOMC decides on option two or three, we should see some rally in the stock market as this Fed action should aid to the economic recovery, but USD should drop especially against JPY on the fact that a second round of debt purchases is needed in order to ensure U.S. economic recovery.

With Bernanke's July 21 testimony on the "unusually uncertain" outlook for the market and the fact that the Fed. is "prepared to take further policy actions as needed.", market is anxious today at what will be the final decision. Even though there is no change expected in the Federal Funds Rate, recent NFP release has pushed expectation for some policy change by the Fed to the highest degree.

Prior to the NFP release on Friday, Bernanke stated that consumer spending is likely to pick up while James Bullard agree that recovery will continue on... Charles Plosser, Philadelphia Fed stated that "second stimulus" is still pre-mature, but all of these statement means very little after the NFP last Friday...

So to translate into today's FOMC meeting, here is what we should be looking for:

The Trade Plan
If there are relatively no change in the FOMC statement and no changes in policy, i.e. as expected release, we should see some strength returning to the USD... As stated in the Upcoming News, I'll be looking for LONG trades on the USD/JPY and USD/CAD...

If Fed announces further debt purchases, we could see stronger JPY and stronger Euro... It is likely USD may drop and continue on for days if not weeks to come...

The most likely scenario is a reiteration of recent rhetoric with a slightly more downgraded short-term forecast... and if this is the case, it's best to stay out of the market...

Additional Thoughts
We may see some strong volatility in the market, moving sharply up for 20 minutes and then sharply down for 20 minutes, and at the end of the day, back to the pre-release levels... If you chase the trade as market goes up and down, you are surely going to lose. The best way is to wait for the market to come to you, if there aren't any strong statement to tilt market balance, you can very well look to BUY from the bottom and SELL from the top...

Additionally, if the market sentiment is biased, expect to see further movement in the market for days to come... usually we'll see a delayed reaction that lasts for days as the Asian and European markets respond to the FOMC decision.


Thanks,


 
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