Browse
related articles
By Kathy Lien, Chief Strategist of DailyFX.com
How to trade the Fed rate decision
The FOMC interest rate decision is less than 24 hours away and the currency market is itching for a breakout.
FX option volatilities are nearing four month lows and whenever they get to such extreme levels, a sharp expansion in volatility is usually right around the corner.
USD/JPY for example has been fluctuating within a slightly more than 100 pip trading range since last Thursday while the EUR/USD has been trading within a 200 pip range.
The Federal Reserve interest rate decision is one of the most market moving events in the currency market and given the recent contraction in volatility, we are almost certain that currency traders will not be disappointed by the volatility induced by tomorrow's announcement.
For the first time since August, the Federal Reserve is expected to leave interest rates unchanged. With inflationary pressures continuing to grow they have no choice but to put an end to their eight month long easing cycle.
However their decision tomorrow will not be an easy one because the outlook for growth remains grim.
The Conference Board reported today that consumer sentiment fell to the lowest level in 16 years, while house prices dropped by the most on record and manufacturing in the Richmond area slowed to a 4.5 year low (Full FOMC Preview).
With this in mind, the Federal Reserve will have a particularly difficult time picking their words for the FOMC statement. There is just as much chance that they will run out with their guns blazing by being unambiguously hawkish as they may try to buy themselves time before the August meeting.
The best way to trade the FOMC meeting is reactively, or following the Fed announcement. Given the significance of this meeting and the fact that market is skewed heavily in favor of a rate hike before the end of the year, there should be decent continuation a few hours following the announcement and most likely for remainder of the week.
Before the FOMC decision, durable goods orders and a report on new home sales are due for release. Mortgage applications have been on the rise, so there is a decent chance that new home sales could rebound.
Euro: France versus Germany
The Euro strengthened against the US dollar thanks to stronger economic data from France.
Even though the near term fate of the EUR/USD will be largely dependent upon the outcome of the FOMC rate decision tomorrow, it is worth noting there is a growing divergence between economic growth in the Eurozone's two largest member countries.
Over the past few weeks, we have had a number of disappointments from Germany including a sharp drop in business confidence and weak retail sales. France on the other hand seems to be chugging along.
Consumer spending rose 2% last month, more than double the market's expectations. This has helped to keep business confidence steady even though analysts expect it to fall in the coming months.
German and Italian consumer confidence on the other hand did not fare as well. That is probably why ECB member Orphanides was the latest central bank official to say that the market's expectations for a July rate hike is appropriate but anything beyond July is up in the air.
Meanwhile despite a sharp drop in the UBS consumption index, the Swiss Franc has strengthened against the Japanese Yen and Euro.
Kathy Lien, Chief Strategist, Daily FX
