FOREX TRADING

FOMC Meeting Wednesday, No Change Expected

The FOMC will conclude a two-day policy meeting on Wednesday the 27th of January and announce its policy decision at 14:15 PM ET. The FOMC is widely expected to maintain steady rate policy and 0.0 to .25%. At the December FOMC meeting the FOMC concluded that economic conditions warrant maintaining yields a low level for an ‘extended period’ and the economy is strengthening. The FOMC is expected to reaffirm commitment to maintaining low yields for an extended period at Wednesday’s policy meeting. If the Fed were to surprise and drop the extended period language from statement it would be a sign that the Fed is shifting monetary policy and preparing its tightening cycle. This is unlikely at Wednesday’s policy meeting because there has not been a significant change in the US economic outlook since the last policy meeting. In December Fed officials said that the economy is improving and that inflation pressures were likely to remain subdued. Recent US economic data has been mixed with Christmas retail sales weak, improvement in the housing market slowing and December unemployment disappointing.

The trade will be closely monitoring the FOMC statement for any new information on the exit strategy from quantitative ease or to see if Fed officials have fresh concerns about the economy and banking sector which would warrant expansion of quantitative ease. A removal of the extended language from the FOMC statement or more definitive indication of the timeframe for the Feds exit strategy would be positive for the USD. Any indication that the Fed may consider expanding quantitative ease would be negative for the USD. The general consensus among economists is the Fed is unlikely to begin hiking rates until the end of Q3 2010 at the earliest and will allow the special liquidity facilities to expire February 1st as announced at the June policy meeting and MBS purchases to end on March 31st.

The trade will also be interested to see whether the FOMC makes any comments in regard to a Bloomberg report which says that the Fed is considering the option of using the interest rate paid on excess reserves as the new benchmark interest rate replacing Fed funds. According to the Bloomberg report the Fed’s Lacker said that the Fed may want to consider using the interest rate on excess reserves as the new benchmark and letting Fed funds trade with a spread to that rate. In theory this would allow the Fed more control over its Fed funds target and could become a tool for withdrawing liquidity which was flooded into the system by the Fed after the collapse of Lehman. The Fed flooded the financial markets with $1trln to prevent the economy from collapsing after the September 2008 bankruptcy of Lehman Brothers. Since 2008 The Fed has been unable to control the federal funds rate since the Lehman collapse. In the past the Fed controlled Fed funds by buying and selling treasuries or withdrawing cash from system but this has not been effective since the Fed flooded the markets with liquidity. Shifting to a new benchmark would offer the Fed an additional tool to begin tightening of monetary policy when the FOMC decides the time is right. Fed fund futures indicate a Fed rate hike is not likely before November at the earliest.

One final issue that will be not be addressed by the FOMC is a consideration of whether the upcoming battle for Fed Chairman Bernanke’s confirmation for second term will weaken the Fed and indirectly influence Fed policy. The White House expects Bernanke to be reconfirmed but his confirmation will likely be by the narrowest of margins. Lack of broad support for Fed Chairman Bernanke could increase the risk of politics influencing Fed decisions which could ultimately undermine the credibility of Fed policy. The confirmation hearing is expected later this week.

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