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Markets Ready For Deep Fed Cut, How Will The Dollar Respond?

Tue, Mar 18 2008, 06:14 GMT
by John Kicklighter

FXCM

Financial markets may be on the edge of collapse and the US economy already steeped in its first recession since the early 90’s. Conditions have grown progressively worse over the past few weeks and months as confidence in the credit markets has crumbled and unemployment has signaled the end of the consumer’s support for growth. However, what makes the situation even more dire is that policy makers efforts’ to stabilize the markets have all failed. Since September, the Federal Reserve has taken dramatic steps to try and jumpstart the markets.

Trading the News: FOMC Rate Decision

What’s Expected

Time of release: 03/20/2008 18:15 GMT, 14:15 EST
Primary Pair Impact : GBPUSD
Expected: 2.25%
Previous: 3.00%

How To Trade This Event Risk

Financial markets may be on the edge of collapse and the US economy already steeped in its first recession since the early 90’s. Conditions have grown progressively worse over the past few weeks and months as confidence in the credit markets has crumbled and unemployment has signaled the end of the consumer’s support for growth. However, what makes the situation even more dire is that policy makers efforts’ to stabilize the markets have all failed. Since September, the Federal Reserve has taken dramatic steps to try and jumpstart the markets. Their effort have run the gamut with verbal intervention, emergency lending, lowering the discount rate and repeated cuts to the Fed Funds Rate. The most recent round of policy shifts has been the most dramatic yet. The last monetary policy meeting in late January brought an unexpected 75bp cut to the benchmark lending rate and the discount rate followed by a scheduled 50bp cut to both measures a weak later. Though this was the largest cumulative easing to lending rates in a single month since 1984, the market wouldn’t respond. More recently, the Fed has tried to stabilize the markets through its other policy devices. The most significant effort has come in the past week when Governor Ben Bernanke has opened the discount window and promised $200 billion of temporary loans to large banks that could be accessed with investment-grade mortgage back securities as collateral. Looking ahead to Tuesday’s rate decision, investors will be looking for a dramatic move from the Fed to save the economy. However, while a dramatic shift in interest rates may help the economy and financial markets, it could also drive the dollar to even greater lows.

A dollar-positive outcome for the rate decision is a low probability, because what is good for the currency is not good for the economy. Interest rates are a primary component of a currency’s value; but lower encourage lending and economic activity. It is clear from the Fed’s policy over the past six months that the Fed is more concerned with growth and financial markets rather than the dollar. The market haas already accounted for this and has discounted a high probability of a full percentage rate cut. There, we will look for a 50bp or shallower cut (and perhaps increased liquidity) as a dollar-bullish outcome for this event risk. With a confirmed, bullish slant to the data we will look for a five-minute red candle to confirm entry on two lots of GBPUSD. Our initial stop will be set at the nearby swing high (or reasonable distance) and this risk will determine our first target. Our second target will be based on discretion (with a mind to support around 2.00 and 1.9750) and to preserve profit we will move the stop on the second lot to break even when the first half of the trade reaches its target.

On the other hand, a bearish outcome is already heavily discounted. We will need a cut that is at least greater than the official consensus (75bp) to encourage a directional trade. We will follow the same strategy for a short as the long above, just in reverse.

How much do you think the Fed will cut on Tuesday? Cast your vote and discuss Dollar's reaction in the DailyFX Forum.

Read more articles dedicated to the  FOMC Rate Decision.

Published on  Tue, Mar 18 2008, 06:22 GMT