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Research Note: August 12 FOMC Statement
Brian Dolan, Chief Currency Strategist
Summary Outlook: On Wednesday at 1415EDT/1815GMT, the FOMC will announce its interest rate decision, which is widely expected to be a steady 0.0-0.25% Fed Funds Target Rate. That leaves the Fed press statement to convey any changes in the Fed's thinking and outlook for the US economy. Market expectations are currently low that the Fed will signal any significant shifts to monetary policy or the economic outlook, but we think the Fed may signal it will discontinue its Treasury bond purchases, and this may have significant positive implications for the USD.
If the Fed were to indicate it would not expand its Treasury bond purchases beyond the $300 bio previously announced, expected to be completed in the autumn, it would signal the beginning of the end of the Fed's quantitative easing and remove a major USD-negative potentiality. (The announcement of an expansion to the Treasury bond buying plan would likely see a distinctly USD-negative response). Such a move could also be interpreted as the end of the Fed's balance sheet expansion and implicitly suggest the Fed is laying the foundation for an eventual shift to higher rates, though we think that is still many, many months away. It will be much easier for the Fed to rein in its balance sheet than to begin to tighten rates, especially since the asset purchases have failed in their principal objective of holding down consumer lending rates.
Trading Strategy: An end to Treasury bond purchases would be an unambiguous USD positive, in our view, but it would hold mixed implications for overall risk sentiment and the JPY-crosses. We think the best trades would involve being long USD against all but the JPY going into the FOMC statement. Should the Fed statement contain no major changes in the outlook or balance sheet management plans, the market reaction should be minimal and long-USD positions could be exited without too much risk.
In USD/JPY and the JPY-crosses, the market reaction to the suspension of Treasury purchases is most likely to resemble the post-NFP reaction from last Friday, where the USD generally moved higher, leaving many of the JPY-crosses in mixed territory, so we would stay out of the JPY-crosses. An end to balance sheet expansion could see Treasury yields move higher, as bonds are sold, sending USD/JPY initially higher. But it could also prove unnerving to risk appetites, if it's seen to be a premature exit from monetary accommodation, potentially sending stock markets lower. To complicate matters, however, if the Fed's shift is interpreted as a vote of confidence in the overall US outlook, stocks could bounce back, taking JPY crosses higher. Overall, we think the event risks are USD-centric, so that is where we'll focus our attention.
In terms of overall volatility, we would note that generally illiquid, summertime, NY afternoon trading conditions will prevail, and that suggests that if there is a market reaction, it will likely be quite persistent. Market positioning is still heavily skewed toward USD-shorts and this condition would also likely amplify any USD-positive moves.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
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