FOMC decision to dissolve FX market indecision?

By: Kevin Sollitt
Aside from an ‘unchanged’ rate decision by the Fed on Wednesday, at this point the other most likely outcome is for a potentially large-range on low-volume trading session as bets are removed prior to the statement and then replaced by new ones.

There appears to be an increasing likelihood that the accompanying language will reflect a concern that rates are approaching the point of being too low at current levels, albeit that the U.S. is merely at the very earliest stages of recovery.

The end of Quantitative Easing (QE) will certainly not be abrupt given the scale and magnitude of the policy but the groundwork could be laid for adjustment, especially given recent comments from officials like Bernanke and Geithner that allude to the idea of an end to the recession being at hand; a theory perhaps supported by evidence accumulating from other parts of the global economy (Australia, Norway) where central banks are raising interest rates. Even the ECB are concerned that cash is trading too far below their target rate.

So what does this all mean for the Dollar? On brief review of happenings in Japan and the UK, there seems to be evidence that a little QE is (perhaps counter-intuitively) actually good for raising the external value of a currency. Cable (GBP/USD) has appreciated by twenty percent in this cycle from its lows at around 1.35 and appears set for more gains if 1.57 holds. Similarly in this current cycle, USD/JPY has fallen from around 110 to 90.

The USD itself rose against the EUR from 1.60 to 1.45, a lesser move but still 10 percent.

If this logic makes sense, then a Fed decision to leave rates and language the same should therefore mean a stronger Dollar, driven by the market’s penchant to buy USD on risk-aversion, a theme that would likely continue if the need for QE and low rates continued for another extended period.

A Fed decision to alter the language as we expect may naturally have the opposite effect with a lower USD most likely to transpire as risk appetite raises, the market effectively seeing that the worst is now behind us.

As suggested on Monday with the GBP approach and yesterday with the observation of market sentiment, from a tactical perspective it will be very interesting to see the knee-jerk reaction to hints over a change in policy as we are still in the midst of great uncertainty on fundamental and technical levels.

A word to the wise if entering trades in GBP or EUR after the Fed: the Bank of England & ECB also meet on Thursday and the ramifications of these two meetings are also ‘unknown unknowns’, suggest keeping exposure tight until a break occurs in these crosses. Instead, play AUD/JPY where similar such news normally likely to affect values has already been released for this month.

Our current projection sees risk-aversion confirming a Head & Shoulders pattern becoming completed as the down move extends to 76.50 from current 81.70, having flirted with the 85 level a couple weeks back. Pro-risk may see the current level serve as a springboard to retest and maybe even break the highs. Whichever cross is preferred, price action suggests keeping it real by having small positions with stoploss intact yet far enough away that trades can stay alive on a counter-directional short-term flush. Good trading.