Currencies and equities have been consolidating ahead of Wednesday’s Federal Reserve monetary policy announcement, says Kathy Lien of BKForex.com.
It is the most important event risk of the week and the most likely catalyst for breakouts. With that said, US retail sales will be released before FOMC and the outcome will affect positioning before the rate decision. Consumer spending plays a very important role in Fed policy and a slowdown in spending amidst an Omicron scare could ease expectations for faster tightening next year. When Fed Chairman Powell said it is time to retire the term “transitory inflation” in the first week of December, he gave investors time to price in an earlier end to Quantitative Easing next year.
Now, investors are looking for answers to three questions from the December rate decision:
- How much will the Fed taper per month?
- How many rate hikes next year?
- What are the growth and inflation forecasts?
Currently the Fed is on pace to reduce asset purchases by $15 billion a month. We are looking for the Fed to double that amount to $25-$30 billion and anything less than that could send the US dollar tumbling. The larger the monthly reduction, the more bullish for the dollar and bearish for stocks.
The last dot plot was released in September and, at the time, only one rate hike was penciled in for next year. Nine out of 18 members predicted a rate hike in 2022. With inflation near a four-decade high, over half of US policymakers will favor a hike next year and a growing number will be looking for 50bp of tightening. The US dollar will trade sharply higher if more than half of the Fed sees two rate hikes next year.
The inflation forecast could be revised higher but with growth peaking before Omicron, their GDP predictions could be shaved lower, which would be bearish for the US dollar.
We will also be looking to see how the Fed describes inflation going forward with the word transitory disappearing from the FOMC statement. The FOMC rate decision, dot plot, and economic projections will be released at 2:00pm ET followed by Powell’s press conference at 2:30pm ET.
As for trading the FOMC rate decision, there are three approaches. The first way and probably the riskiest is to position for more aggressive tightening by the Fed next year and take a trade before the announcement—getting out shortly thereafter because oftentimes the initial move is given back quickly, as traders who took positions before the rake decision take profits after the initial release.
The second way to trade FOMC is to wait about 30-45 minutes after Fed Chair Powell speaks, let the market is make its final assessment and buy or sell on the break of post reaction, high or low. The third way is to simply stand down, wait for all of the dust to settle and trade at the Asia open.
To learn more about Kathy Lien visit BKForex.com.