In a matter of hours, we will know what the Fed will or won't do to aid the U.S. economy.
Here's a trading plan.
Today, the markets are on hold until the white puff of smoke is released by the FOMC and we find out their plans to aid the US economy. Given the recent deterioration in the US economy, 58% of economists believe the central bank will extend the MEP (maturity extension program) known as the Twist. At this point, the Fed has shifted $383 billion of the $400 billion targeted from short-term securities into long-term securities.
The Fed has about $190 billion of debt with short-term maturities to continue the Twist for another three months, according to news reports. To extend beyond three months, the Fed will have to increase its risk profile by utilizing other securities like mortgage-backed bonds.
Given the Fed has already increased its balance sheet to $2.3 trillion by their quantitative easing program, the central bank appears to be limited in its ability to be more aggressive by increasing the assets on the balance sheet. Also, they risk serious political blowback if they act overly aggressive in the middle of an election that is extremely close and centered on the economy.
Here’s my simple playbook for the FOMC meeting.
1. If the FOMC increases QE, then buy EUR/sell USD
2. If the FOMC extends the Twist, then sell EUR/buy USD
For #1, additional asset purchases would be a surprise to the market and would be a negative for the US dollar.
For #2, this is what the market is expecting and will bring profit taking on long EUR/short USD positions.
I think the biggest move will come from #1 and there isn't a lot of downside risk for #2.
This is a short term trade based on the FOMC doing more asset purchases. If the central bank doesn’t act, don’t have this on.
Trade: Buy EUR/Sell USD
There are several outcome variations on the meeting, from the announcement at 1PM ET to the forecasts at 2PM ET to the presser Bernanke gives at 2:15 PM ET. All have the potential to cause strong movements in the EUR/USD, but the dominant action will be driven by what the Fed does and not what they say they will do. A surprise add to QE will drive down the value of the US dollar.
Andrew B. Busch Director, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a contributor to CNBC's Money in Motion Currency Trading.You can comment on his piece and reach him here and you can follow him on Twitter at http://twitter.com/abusch .
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