Forex Analysis For US FOMC Interest Rate Decision

Today’s FOMC Meeting will probably not impact the market as much, as the Fed probably ran out of new measures to stimulate the economy.  As a matter of fact, most analysts agree that the Fed will be leaning towards providing a “clearer guidance” rather than a policy change, or in other words, inflation and unemployment targets for rate changes…  With the Fed keeping rates at around 0.25% for the past three years, adding two rounds of Quantitative Easing (QE1 and QE2), Operation Twist by swapping shorter-term bonds with longer ones, and the latest joint liquidity operation with other central banks by cutting the USD swap rate to 0.5% above the OIS, there aren’t much left for the Fed to announce today except for perhaps QE3…

However, with the recent positive figures in the US Employment figure and the surprising drop in Unemployment Rate, the Fed will probably refrain from any further QE announcements, and adopt a wait-and-see approach, until perhaps after Q1 of 2012;  therefore, what some analysts are expecting is the modification in language of the “mid-2013″ phrase and move to a target based approach where the Fed will plan to end the easing cycle (keeping rates low) if and when the Unemployment Rate falls below a certain level and the inflation goes above a certain level – and Chicago Fed President Charles Evans has stated that 7% on the Unemployment and 3% on the Inflation seems to be the right combination for him…

Whether or not the Fed will adopt this “clearer guidance” is still up for debate, as some analysts disagree on how much weight to give inflation versus employment, and let’s not forget that expecting the Fed to commit to any kind of forecasts may very well be too ambitious… but in this market condition and the fact that the Fed is still expect to do more, anything can happen…

Here’s what I’ll be looking for in today’s FOMC statement:

"Information received since the Federal Open Market Committee met in September indicates that economic growth strengthened somewhat in the third quarter, reflecting in part a reversal of the temporary factors that had weighed on growth earlier in the year. Nonetheless, recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has increased at a somewhat faster pace in recent months. Business investment in equipment and software has continued to expand, but investment in nonresidential structures is still weak, and the housing sector remains depressed. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable."

I’ll be looking for some upgrades in the language as situation has been improving continuously since then.  The inflationary pressure continues to moderate as USD gained across the board and push most commodities lower, so there may also be some more changes in the upcoming projections… here is the Nov. 2011 Projection:



"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations".

I’d expect this paragraph to remain largely unchanged…

"To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate".

"The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013".

This is where I would expect some changes, perhaps with a guidance based target, as proposed by Fed. Evans.  If this were to be the case, I’d expect to see some risk on sentiment (risk appetite) as now the Fed is practically putting no time-line to increase rates.  Thus allowing the current rate to be accommodating for as long as it needs to be… thus we may see some strength in the commodity currencies, including the AUD, NZD, or even CAD… (AUDJPY may be a good pair to go LONG, possibly).  However, if this paragraph were to remain mostly unchanged, then probably we won’t see much market reaction…

The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.

There two paragraphs will probably also remain unchanged, but if the Fed signals future QE3 here, expect to see market react in heavy risk appetite fashion.

All in all I believe the Fed will probably be vague today.  Some analysts believe that the Fed will probably wait until January 24~25, 2012 meeting to announce policy changes, but just in case we get a surprise today, we should expect some risk appetite sentiment dominating the US afternoon.