Unless you’ve been living in a cave, you probably know that a historic moment could be upon the US economy. The Fed might decide on the first rate hike in a decade on Wednesday. While “To Hike or Not To Hike” is the main topic of discussion between Janet Yellen and her crew of policy makers, “To Freak Out or To Chill” is in the minds of investors.
To be fair, the market is already freaking out on the rumors of a rate hike. So how can the results move the currency market, and especially the US dollar? First, let’s take a look at some facts.
US Dollar Rose Prematurely on Rate Hike Rumors
Ms. USA (US dollar, USD) has been subject to ridiculous overbuying, as interest rate hike expectations have actually been priced in since early 2014. Around that time, the Fed had already started unwinding their stimulus program by tapering asset purchases, putting them on track towards eventually increasing borrowing costs.
On the bright side, the US economy has continued to produce jobs and to grow, which are all good things for Ms. USA. However, in the past couple of weeks, the US dollar has been reacting to positive news in a weird manner. She dropped against her major dancing partners on positive Non-Farm Payrolls (NFP) report last week for instance.
This could be a classic case of “buying the rumor and selling the news”. Basically, market participants have already priced in their expectations for these policy decisions months ago, pushing the currency in prolonged trends even before the actual announcements confirmed their biases. And once the decision turns out as expected, those who’ve caught the longer-term trends take it as a cue to go “Ha! I knew it!” before booking profits, triggering a sharp reversal in the process.
This has actually been a trendy reaction among most currencies on the forex dance floor recently. Remember Mr. Euro and Mr.Kiwi moves on rate cuts?
Fed Rate Hike Could be Gradual
While Ms. Yellen seems to be very pleased with the economic growth, she has mentioned a “slow pace of tightening” quite a lot. So even in case of a rate hike, market participants could get disappointed by quick cautious remarks that may follow. I wouldn’t be surprised if Ms. Yellen says something about wanting to wait much longer before hiking interest rates again or being willing to undo any tightening moves if the economic situation worsens in the coming months. This could lead to US dollar sell off during the initial hours of the announcement.
Forex Trading Strategies
1- Loosen up your stop loss today: If you are already in a USD position, widen your stop loss to avoid getting kicked out of you position on a market knee-jerk reaction to the event risk.
2- Buy USD if the Fed raises interest rates, but the dollar moves down: As I explained above, the initial reaction of the market to a mild interest rate hike could actually be negative. But since the US economy seems to have a bright future ahead, we could say that the drop could be a perfect timing to get in a long-term bullish position. Buy low and sell high, eh?!
3- Don’t trade if they don’t hike rates: If the Fed decides to surprise the market with a dovish rate action, Ms. USA could become more confused than ever and it will be hard to forecast her moves immediately. We would have to wait for the FOMC meeting minutes to come out to understand the true nature of the Fed’s projections.
Keep in mind that Ms. USA has already erased her gains versus many of her counterparts including Ms. Euro, Mr. Kiwi and Mr. Japanese Yen. So there is a possibility that she is now ready to get back on the bullish track after having rested for a few weeks.
For customized trading strategies for your account and to look into different currency pairs, book in a private lesson with yours truly today. We’ve even created a 30% discount that is only valid until Thursday. Our classes are nearly full so book in before we run out of open sessions.
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