Look past the FOMC for the next trade

January 29, 2014 by Nanakiver3

The 1900 GMT FOMC statement is likely to add some more fire to an already volatile market. Despite most market participants expecting the Fed to taper QE by $10bn to $65bn by cutting MBS and treasury purchases to $35bn and $30bn there are some who feel the recent disapointment in US data could cause the Fed to hold back on tapering. This coupled with some market participants with the view they are likely to cut the employment target to below the current 6.5% is likely to cause further volatility in the markets should they disappoint.

Benanke has strongly suggested that the Fed is inclined to reduce purchases in $10bn increments, which should allow QE to end by October. This is despite the softer date recently with the main focus on the January NFP release.

In terms of forward guidance, the market expectations are for the unemployment threshold to stay at 6.5% for the first rate hike and until “well past the time that the unemployment rate declines below 6.5%”. With this in mind there are some participants that suggest that a push lower in the unemployment threshold.

In terms of the data so far, the releases in December have surprised the market to the downside again the most out of line was the NFP read in January, most analysts feel this was due to adverse weather conditions and that the Fed may note this in there report suggesting the Fed may hint at further improvements ‘in recent months’.

What does this mean to the markets?

No taper would be a shock to the market based on the rhetoric given by Benanke at the last meeting, this is likely to see treasuries rally across the board and dollar selling.

$10bn taper, this is likely to cause some initial volatility with the markets calming after. I don’t expect much in the way of movements in the dollar and treasury space.

Should the Fed look to lower the freshold for unemployment this is deemed highly unlikely by market analysts, but is likely to cause an initial move lower in the dollar and a push higher in treasuries.

As I mentioned earlier, if the Fed tapers I like short AUDUSD and long USDCAD and USDJPY, if they don’t then go long EURUSD and GBPUSD and short USDJPY.

The reason for this is the market reactions to the last Fed announcement and the subsequent moves in the market since then. EUR and GBP have outperformed the AUD and CAD and I expect this trend to continue as the AUD and CAD central banks hint at loser monetary policy, with the Europe and the UK showing signs of growth.