US Federal Reserve Monetary Policy Announcement – Short Term Outlook for USD Pairs Mixed?
The US Federal Reserve will announce its decision on the official interest rate at 19:00 GMT today with the consensus expecting that the rate will be left on hold at 0.25%, the level that has been applied since January 2009.
At the same time, the Fed will release its monetary policy statement in which further insights may be given into its tightening intentions.
As shown in the graph below, USD exchange rates have been more volatile than the norm on the monetary policy announcement date and the option markets are still currently pricing in a higher volatility.
The volatility for US dollar pairs in the above graph on announcement day has been 2.4% points higher on average than the norm (vs 0.8% lower for the non-US dollar pairs). The implied volatility (of at-the-money daily call options) is currently 8.4% points higher than the norm for the US dollar pairs vs. 6.1% for the non-US dollar pairs.
Value considerations
In the last week, the US dollar index strengthened 1.1% with larger gains against the AUD, CAD (0.25% cut in Canadian official rate) and EUR (euro 60 bn per month bond purchase program). The graph below compares price movements vs. our assessment of fair value movements over the same period and shows a mixed bag in terms of indicated trade directions for the pairs.
The above results normally would suggest taking short term long positions in USD/JPY and AUD/USD and short term short positions in USD/CAD, EUR/USD and GBP/USD. This strategy would also mitigate the risk of the monetary policy announcement.
Our backtesting over the most recent 90 days (see graph below) suggests that trading the price/value movement divergences in this way would have been reasonably profitable across the five pairs. Also, the volatility from trading an equally weighted portfolio would have been significantly lower than trading any of the pairs individually. (The lowest volatility for trading any of the five pairs individually was 7.3% – for GBP/USD – when it was 4.8% for an equally weighted portfolio of the five).
