FOMC Scenarios: What it Means for the USD

September 17, 2015

FOMC Thursday has arrived. The day markets get a decision out of the most anticipated, divided and unknown Fed meeting in years!

Today the US Federal Reserve will make their call on whether to provide liftoff on interest rates, as well as fielding any questions from the press on changes to monetary policy and economic projections. With the futures market forecasting a less than 20% chance of a hike, there is immense trading opportunity in the case of a surprise from the Fed who is obviously still very undecided.

Having been at near zero levels for so long, markets have become distorted which has a flow on effect from the excess liquidity that free money provides. The Fed knows that it must act to restore a level of normality to the economy but with a multitude of both internal and external factors coming into play over the last few months, there is huge downside risk if the Fed gets their forecasts wrong and hikes rates on an economy that can’t handle it.

I’m normally not the biggest fan of listening to what the big banks have to say, but this snippet from Bank of America, Merrill Lynch summed things up perfectly:

“The macroeconomic data largely appear good enough for the FOMC — at least if the majority of Fed speeches over the past several months, culminating in Vice Chair Stanley Fischer’s remarks at Jackson Hole, are any guide.”

“The remaining question is the amount of financial volatility into the meeting, and whether Fed official will react to it. Relatively little may be gained from waiting. The uncertain global outlook (focused on China) will take time to sort out. Meanwhile, the labor market has improved more quickly than Fed forecasts, with the unemployment rate dropping below 5% by early next year, if not sooner.”

FOMC Scenarios:
Below we take a look at the possible scenarios on the table, but first of all let’s take a look at the US Dollar Index from a technical point of view.

USDX Daily:
Click on chart to see a larger view.

As we spoke about in today’s Daily Market Update – The Fed’s Inflation Complication, we see price sitting in the middle of a short term bearish channel. After breaking that major bullish trend, you can see that price has just drifted aimlessly sideways, waiting for direction from the Fed.

So onto the big question. Where to now for the US Dollar?

1) Hike – Hawkish guidance.
Under this scenario, the Fed would possibly signal another rate increase before Christmas. This would be VERY bullish USD.

2) Hike – Dovish guidance.
This scenario would see the Fed use language such as ‘data dependent’ and ‘no clear signal of when the next hike will be’. The headline hike in rates would be initially bullish USD, but would most likely see a large reversal possibly to make new lows.

3) No Hike – Hawkish guidance.
Here we would see rates being left on hold but talk of ‘imminent hikes’. Like the previous scenario, the USD would most likely react to the headline of rates on hold, this time dropping it hard. However, once markets start to digest the Fed’s hawkish rhetoric about a hike possibly as early as October, the reversal rally would come.

4) No Hike – Dovish guidance.
This scenario would signal to markets that the Fed has majorly changed course and taken lifting rates almost completely off the table for the foreseeable future. This would see a catastrophic drop in the USD and a huge equities rally as money floods back into stocks and yields fell.

With markets pricing in a 80% chance of the Fed leaving rates on hold, the greater risk is to the upside if they do actually hike.

“The most likely scenario in my opinion is #3 – No hike with dovish guidance that signals they are still on track to hike before the end of the year.”

Greater volatility brings opportunity if you prepare properly and manage your risk correctly. If you have any concerns about position sizing or account funding heading into the release, please don’t hesitate to contact us at Vantage FX.

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What are your thoughts on the above FOMC scenarios?

Dane Williams – @VantageFX

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