Trading the FOMC Decision

During their previous statement, the FOMC noted that economic activity was picking up and that the labor market was stabilizing. However, they pointed out that lending remained weak and consumer spending was still restrained.

According to Fed Chairman Ben Bernanke, this warranted an “extended period” of low rates. However, Fed official Thomas Hoenig once again dissented, saying that the Fed should drop all that talk about keeping rates at low levels and adding that the rate should be hiked to 1%.

Will the Fed finally remove the phrase “extended period” when talking about how long they’d keep interest rates low? It seems like Big Ben is the only one being extra cautious about their monetary policy stance.

While analysts don’t expect any changes to the Fed Funds rate, the accompanying statement could be a little bit more optimistic than last time, especially with all the on account of all the better-than-expected results on the most recent data on employment, housing, and manufacturing.

The non-farm payrolls, which measures the net number of jobs created or lost over a certain period, posted its first ever gain in the last, uh…. Let me count… 26 months! Meanwhile, existing home sales and new home sales both managed to beat forecast by a significant margin.

Lastly, the ISM manufacturing purchasing managers index (PMI), which is considered one of the best leading indicators when it comes to the manufacturing industry, printed a 59.6 reading, higher than initially predicted and the previous month’s score of 56.5. Since it is above the “line in the sand” figure of 50.0, it means that the manufacturing industry actually experienced expansion in March.

In any case, if tomorrow’s policy decision shows that the Fed will maintain its previous rhetoric of holding the Fed Funds rate between 0.00% and 0.25%, the dollar could weaken again as it did previously. The dollar’s losses would probably be limited though, as this has been the case in the previous rate announcements.

On the other hand, if the bank drops the phrase “extended period,” we could see some serious dollar buying. The Bank of Canada was the latest central bank to relax its easing stance. And, as we all know, the market took it as a signal for a possible shift in policy which boosted the Loonie by more than a hundred pips against other major currencies.

In the coming months, we can probably judge how aggressive (or passive) the Fed will be in its monetary policy by taking clues from the labor market and the pace of inflation. As I’ve pointed out, employment figures finally rose last month. Was it the beginning of more good things to come? Will we see the labor market meet the fearless forecast of 500,000 new jobs monthly by Mr. Joe Biden?!? Seriously though, 500,000?! C’mon Joe, even I’m not that optimistic!

As for inflation, we should be keeping an eye out for personal consumption expenditure (PCE) data. Fed members have repeatedly said that they expect inflation to be subdued. But what happens if we see a sudden rise similar to what’s happening in the UK? If inflation rises faster than anticipated, it might just cause the Fed to get off their butts and start raising rates!

For the meantime, while you wait for the FOMC statement on Wednesday, watch out for Big Boss Bernanke who will be speaking tonight before the National Commission of Fiscal Responsibility and Reform. He’s going to be asked tons of questions, which are probably meant to catch Bernanke off guard to figure out what approach the FOMC is going to take.

Will Bernanke finally drop his oh-so-favorite catch phrase of “keeping interest rates low for an extended period?” Stay tuned my forex friends and may the FOMC force be with you!