U.S. Dollar: How to Trade Fed Meeting

U.S. DOLLAR: HOW TO TRADE FED MEETING

The U.S. dollar traded higher against every major currency ahead of the Federal Reserve’s monetary policy meeting. There are a few reasons why forex traders should be nervous today, but we believe that the rally in the U.S. dollar is a reflection of the market’s hope that the Fed will come through tomorrow by growing more hawkish and optimistic.

 Equities are hovering near their yearly highs along with 2 year bond yields which indicate that the sell-off was not primarily induced by risk aversion. With some Wall Street economists calling for job growth well in excess of 150k, the Federal Reserve is under pressure to act sooner rather than later. However Fed officials do not easily buckle under pressure because they know that once something is telegraphed, it cannot be readily retracted without triggering sharp volatility across the financial markets.

The Federal Reserve has not raised interest rates since 2008, but they are in the process of gradually implementing their exit strategy. In our FOMC Preview , we wrote at length about how traders will be paying particular attention to the inclusion or deletion of the phrase “extended period” and to the number of dissenters. One of our readers also made a fantastic point about how the Fed could replace or supplement the Fed funds rate with interest paid on excess bank reserves. In early January, Fed President Lacker had openly suggested allowing more flexibility for the fed funds rate to drift higher while leaving the rate on excess reserves at 0.25 percent. We are not sure the Fed is ready to change their main policy tool but if they do, it should be perceived as a hawkish move.

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