Trading Tips for the FOMC meeting

Summary:

• The Fed will decide on rates on Wednesday

• We analyse historical meeting for clues on EURUSD reaction

• A rate is fully priced in, reaction will depend on the dot-chart and Powell’s conference

• Three markets to watch: EURUSD, USDJPY, Gold

Since the beginning of the current cycle the Federal Reserve has already hiked rate seven times and another one is widely anticipated to take place in September. Market participants share a similar view that the Fed will be able to lift borrowing costs again in December. However, with both moves already priced in, the US dollar could struggle to benefit from these rate rises. Furthermore, there are reasons why the dollar could have more difficulties to push ahead from the current levels. In this analysis we use historical examples to judge the possible impact of the Fed’s meeting on three major markets: EURUSD, USDJPY and Gold.

Using history - how did EURUSD react to Fed’s hikes?

The US dollar tended to respond positively to Federal Reserve meetings in the past unless other events arose. Source: Bloomberg, XTB Research

Generally the US dollar tended to respond positively to Fed’s decisions during the past meetings i.e. a hawkish stance saw the USD rising, a dovish one pushed the currency lower. This held true unless other events occurred. We thoroughly analysed the 24 hours following each Fed meeting, hence some conclusions can be drawn.

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On  14 December 2016 when the US central bank kicked off a monetary tightening cycle the US dollar saw an immediate increase which was extended during the next 24 hours. The reason was quite obvious. After years of loose monetary policy, the Fed had to prepare markets for such a move. Even as the rate hike was already priced in, the Fed signalled 3 hikes, more than the markets expected. This in conjunction with the widespread conviction about sizeable space for further strengthening for the US dollar resulted in impressive gain over the next 24 hours following the decision.

A similar outcome took place in 14 June 2017 when the meeting was followed by no other important events. It was a time when investors were concerned about an inflation rebound and its sustainability. Chair Janet Yellen managed to dispel these fears suggesting that inflation had been held back due to temporary factors which were expected to gradually wear off. As a consequence, the EURUSD declined almost 1.2% over the next 24 hours.

The Fed revised up its rate hike path at the meeting in June 2018, hence there is unlikely it could do so once again next week given the development in macroeconomic data. Source: Bloomberg, XTB Research

The meeting on 15 March 2017 was negative for the dollar. The Fed signalled less hikes than expected and moreover polls suggested a EUR-friendly election result in Netherlands. Even as the net effect of this poll faded away after some time, the euro ended the next 24 hours following the Fed decision clearly higher.

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Finally, the last meeting where a rate hike took place was held on 13 June 2018. The bar ahead of the meeting had been set really high (investors had expected the steeper rate path) and all came down to the Fed’s dot-plot seeing a larger number of rate increases both in 2018 and 2019. At the same time the long-term interest rate projection was left unchanged - this was supportive for US equities. The initial move on the EURUSD was positive but then it faded. Notice that the final increase in the US dollar in June (i.e. a major decline on EURUSD) this year was caused solely by the ECB meeting taking place the next day.

What to expect in September?

Expectations are high. The rate hike in September has been fully priced in, hence attention will be again paid to the forward guidance. Given the fact that the Federal Reserve revised up its projected rate path notably three months ago the balance of risks seems to be to the downside. This is especially true when we take a look at macroeconomic releases. Barring the latest unexpectedly high wage jump, data has been falling short of expectations since the beginning of this year (including recent inflation numbers). Let’s add that in case of wage growth one needs to wait for a confirmation whether the last month jump could be sustained or if it was one-off increase (recall that we had similar jumps earlier this year caused mainly by weather). Therefore, the bar for the dollar appears to be set high. At the same time there is a risk the Fed could lift its long-term rate forecast to some extent on the back of expectations regarding fiscal stimulus’ impact on the neutral rate. If so, it could be slightly US stocks negative while the impact on the dollar solely from this change should be limited as it is being more driven by short-term rates. To sum up, traders should watch median projected rates for 2019 and long term and be vigilant to any soft remarks from Jerome Powell during the post meeting conference.

Citi’s economic surprise index for the EMU has been improving since June unlike the gauge for the US. Source: Bloomberg

3 markets to watch:

The EURUSD broke above  the crucial supply area on last Thursday due to the widespread dollar weakness. It has been able to stay there since then. On the flip side, the pair failed to retain gains following a speech delivered by ECB's Draghi yesterday. Either way, that clears some room for the bulls as the next key resistance is at 1.2200. Supports could be localized at 1.1540 and then lower at 1.1300. Source: xStation5

Bulls in the USDJPY market are pushing higher but they are approaching their important resistance in the vicinity of 113.20. Should the Fed disappoint, it could result in a reversal back toward the blue trend line. Source: xStation5

Gold prices have witnessed a dramatic decline since April but they have recovered some of losses recently. The major hurdle is placed nearby $1208/10 and one could expect this level to be broken if the US dollar continues its slide in the weeks to come. A possible breakout would enable gold prices to look at subsequent resistance at $1240, $1263 and finally somewhat above $1300. Source: xStation5