When the U.S. Federal Reserve speaks, the world listens. Here’s a newbie-friendly guide to all you need to know about this week’s FOMC statement!
What the heck is an FOMC statement?
Tomorrow at 8:00 pm GMT the Federal Reserve, central bank of the world’s largest economy, is set to release its monthly monetary policy decision. This usually involves interest rates, monthly asset purchases, and economic outlook of the U.S. economy.
Why is it important this time around?
Market players always listen to what the Fed say but this time around they’re expecting the central to further reduce its monthly asset purchases by $10 billion like they it started doing last month.
Further reductions in monthly asset purchases signal that the Fed is certain enough on the economy’s recovery and is ready to slowly withdraw its stimulus program. This could inspire confidence in U.S. assets. This is particularly a hot topic these days since global investors seem ready enough to take off their investments from emerging markets in favor of developed market assets.
What are possible scenarios?
There are plenty of possible scenarios but we’ll focus on the more likely ones. A favorite scenario is where the Fed would bring down their monthly asset purchases from $75 billion to $65 billion. If this happens, USD could slaughter its higher-yielding counterparts and get boosted to record highs.
Of course, the dollar’s upsurge might already be priced in. We could see a buy-the-rumor-sell-the-news scenario where traders take profits from their positions. There’s also a possibility that further tapering might translate to broad risk appetite, which could also weigh on the dollar.
Last but definitely not the least, the Fed could disappoint by tapering by less than $10 billion or not tapering at all. If this happens, then we could see either broad USD selloff or traders simply going back to their pre-FOMC trades.
Which currency pairs should I watch out for?
Any USD-related currency pair is a candidate but you’ll want to be where the action might be. Pay attention to the majors like EUR/USD, GBP/USD, USD/JPY, and USD/CHF as they usually have the higher trading volumes. USD/JPY’s price action in particular is highly sensitive to the Fed’s actions, as evidenced by its 2013 price swings.
Also keep your eyes on comdoll and exotic pairs. As mentioned above, high-yielding currencies are currently sensitive to the Fed’s taper plans. Any significant optimism on the U.S. economy could drive investors to take out their higher-yielding bets and return to their favorite U.S. assets.
That’s it for today! Again, there are plenty of scenarios that could play out in tomorrow’s Fed decision. While we can’t know how our favorite currencies will react, we certainly can prepare for as many possibilities as we can. Good luck and good trading!