Daily FX Market Roundup 09.16.15
Best Way to Trade the FOMC Rate Decision
The best way to trade the September FOMC rate decision and any major event with this much uncertainty and division is to wait. There is no question that this month’s monetary policy announcement will trigger a significant increase in volatility that will translate into large swings for currencies. In addition to the central bank’s decision on interest rates, Janet Yellen’s guidance will also have a major impact on the market’s appetite for U.S. dollars.
Most investment houses are focusing on the scenarios post FOMC and not on positions that should be taken going into the announcement because everyone from economists to investors and even policymakers are split on the action that the Federal Reserve should take. According to the latest Bloomberg survey, 50% of economists polled are calling for a rate hike and 50% predict no change in monetary policy. Yet considering that Fed Fund futures are pricing in 72% chance of no rate hike, the big surprise tomorrow will be a 25bp increase. Unfortunately trading the September FOMC rate decision is not a simple binary bet of hike vs. no hike. At this meeting, the Federal Reserve will also release its economic projections alongside the rate decision, which will be followed by a press conference from Janet Yellen.
Tactically, we are looking for the dollar to have an initially large reaction to the 2pm announcement followed by a swift smaller magnitude reversal and then a brief consolidation before Yellen’s presser that will cause be a precursor to another rise in volatility. By the time her press conference ends, we expect the dollar to begin its true and lasting move, which could have days of continuation.
There are 4 things that we are watching for at tomorrow’s meeting:
1. Decision on Rates
3. Economic Projections
4. Number of Dissenters
And here are the most likely scenarios along with the potential reaction in the dollar:
1. Hike but imply that they are one and done for the year > Initial USD spike followed by vicious reversal
2. No hike but indicate that rates will still rise this year > Initial USD drop followed by healthy relief rally
3. No hike and no guidance on when rates would rise > Multi-day decline in USD
4. Hike and indicate that more could come in 2015 if headwinds fade and US economy strengthens > Multi-day rally in USD
Scenario #1 and #2 have the highest probability with a greater chance of a dollar decline than rally. However regardless of whether the Fed raises interest rates the dot plot forecast will come down and the growth forecasts could be revised lower. How much it matters to market participants will depend on the guidance. Considering that U.S. policymakers downplayed the timing of the first hike at past meetings and reinforced the importance of the overall path of interest rates, we don’t expect a significant amount of hawkishness from Yellen unless the Fed leaves rates steady because at that point they will most likely signal plans to raise rates later this year.
One of the main things that make the Federal Reserve’s decision so difficult is that there have been both improvements and deterioration in the U.S. economy since the July meeting. As seen in the table below, job growth and manufacturing activity slowed, retail sales increased marginally and consumer confidence was mixed. However average hourly earnings are on the rise, the unemployment rate declined and housing market activity gained momentum. The Fed is afraid of falling behind the curve and there’s enough improvement to justify a rate hike but at the same time strong arguments can also be made for patience.
Meanwhile the best performing currency today was the British pound, which traded up nearly 1% versus the greenback. Despite an increase in jobless claims, the ILO unemployment rate declined and average weekly earnings jumped a whopping 2.9%. Sterling bulls pointed to wage growth as the primary reason why the Bank of England could raise interest rates in the beginning of the year and their optimism was reinforced by today’s reports. U.K. retail sales are scheduled for release on Thursday and due in part to the increase in wages economists are looking for a pickup in spending. However ex autos, retail sales growth is expected to slow to 0.1%.
The Swiss National Bank also has a monetary policy announcement tomorrow. The SNB only meets quarterly so each meeting is more important. While no change in monetary policy is expected the central bank will most likely repeat that rates will remain negative for a long period of time.
Gains in euro were modest compared to the other major currencies because ECB officials continue to talk up the possibility of additional easing. ECB member Constancio was the latest policymaker to say if necessary, there is scope for a further increase in Quantitative Easing.
Oil prices rose 5.7% today, driving USD/CAD below 1.32. According to the EIA, oil inventories declined 2.1 million barrels, the largest drawdown in 7 months. In recent weeks, there has been significant volatility in crude prices but the latest increase takes prices above the 50-day SMA, a sign that further gains is likely. The loonie only moved slightly higher today but between the Bank of Canada’s less dovish stance and oil prices, we are looking for an eventual test of 1.30.
The Australian dollar was the second best performing currency today. Despite a decline in leading indicators, the rebound in Chinese stocks, rise in gold prices and rally in U.S. equities helped AUD/USD extend its gains for the fifth consecutive trading day.
Finally, the New Zealand dollar edged upwards. The current account balance swung from a surplus of 821 million to a deficit of 1.216 billion in the second quarter. While terrible, economists braced for an even larger deterioration. The second quarter’s GDP report is scheduled for release this evening and we are surprised by the forecast for stronger growth given the weakness in retail sales and trade activity.