Federal Reserve decision strategy for the dollar and global markets

Dow, Dollar, USDJPY, NZDCAD and FOMC Talking Points

  • The business perspective: Dow bearish below 34,000/33,000 after the Fed; Gold Bearish vs. 1,850; USDJPY bearish below 113.50 after the Fed, NZDCAD bullish above 0.8750
  • Volatility remains uncomfortably high as we enter the FOMC on Wednesday – the central bank flirting with a faster timetable for rate hikes
  • The Dow Jones and US Indices look particularly prone to fundamental-based volatility while the Dollar is also in tune – in the meantime we still have the BOC, Earnings and Ukraine

Market conditions before – and after – the FOMC decision

All eyes are on the FOMC’s rate decision expected in the afternoon of the New York session (19:00 GMT), but how much or how little impact this event has on markets depends heavily on of the financial context. And, as we have clearly seen in the first 48 hours of this trading week; there is serious anxiety running through these markets with a serious risk of more systemic issues in the future. In other words, there is a greater risk of a sell-off worldwide in risky assets than anything we’ve seen since the pandemic-induced recession and market meltdown. This is what we should really consider when entering heavy event risk and likely volatility in the next session. Moreover, the environment may take precedence over the traditional aspects of speculative appeasement of recent years (complacency, a strong bias towards the short term and the long tactical strategy, rationalization by monetary policy, etc. ).

It is not a certainty, but it increases the risk. The threat can be seen in the extreme volatility of the past two days, record ETF turnover on Monday and the second-largest single stock option expiration on Friday. Exposure is high and trust is eroding. To measure the balance, the US indices remain the most important liquid and exposed combination. For now, the Dow Jones Industrial Average – the “value” index – may be the best signal to help cut through the noise. If we lose 34,000 on the index (340 on the DIA ETF) after the Fed, we will have to be vigilant. If we lose 33,000 (330 on the ETF), traders and investors should be fully tuned into the risk.

Graphic of SPDR Dow Jones Average ETF with 100 and 200 day SMA, volume and ‘Tails’ (Daily)

Chart created on Tradingview platform

The Fed’s rate decision isn’t just seen as a fundamental tipping point for this week – it could very well represent a structural shift for the financial system. Monetary policy has played a vital role in supporting the financial stability and economic recovery so desperately needed after the pandemic, but it would also restore the dynamics of speculative excess that had become an indelible part of the capital market’s rise. in the years leading up to the onset of the 2020 Crisis. While the stretch in risk appetite is not isolated to the US nor to indices – let alone US indices – they have not evolved together for the past two years. Especially over the past year, emerging markets, junk bonds and carry have lagged seriously behind their more popular counterparts in portfolios. Theoretically, markets may find some relief from Fed guidance, but will they really find the basis for genuine enthusiasm to return to record highs? This seems highly unlikely given the added pressure from slower growth projections and geopolitical threats, among other issues.

Graph of the performance of “risky assets” over the last 12 months (daily)

Federal Reserve decision strategy for the dollar and global markets

Chart created by John Kicklighter with data from Bloomberg

The distribution of FOMC scenarios

I am a strong believer in planning different outcomes around big fundamental themes or discrete events. For the Federal Reserve’s monetary policy meeting, we saw the market generate serious interest and anticipation. At the last political meeting on December 15and, the group has significantly improved its views on what lies ahead. Previously sticking to an exceptionally dovish line and anticipating a single rate hike of 25 basis points in 2022, the group abandoned the transitory view of inflation and raised its median forecast to three hikes within the year. Interestingly, the market did not immediately react to the change; but seemed to pay attention later. This is the power of market attention and mood. Right now, we seem to be perfectly tuned – almost hypersensitive. This led to prices in an aggressive forecast of up to four increases, exceeding the central bank’s own view.

There are a few critical elements to this meeting that will determine whether it will fuel further volatility and what direction the market will ultimately take on the Dow, Dollar, Treasury yield, Gold and more. First, a decision at this particular meeting is highly unlikely – and the Fed is trying to avoid surprises. The first serious consideration is whether the band is making a concerted effort to signal a March 16and rise in rates that the market has already priced in. After that, the commentary in the policy statement and Powell’s press conference will be assessed to determine the intention to move four full hikes (100 basis points or 1 percentage point) this year. Next, we’ll look for references to a quantitative tightening schedule that was previously left open, but has recently been mooted by some FOMC members. The outlier for me is whether Powell is making an explicit effort to signal that he and the Fed will maintain a high tolerance for market volatility — in other words, they will continue to cut even if the markets are in a slump.

Federal Open Market Committee Policy and Market Impact Scenario Table

Federal Reserve decision strategy for the dollar and global markets

Table created by John Kicklighter

Of the markets particularly sensitive to the upcoming monetary policy adjustment, I wouldn’t say that US indices like the Dow have been the most volatile metrics. However, they are not necessarily so attuned to the real rate outlook. Sentiment is “looking for a reason,” but dollar futures, yields and fed funds appear to be far more sensitive to the actual ebb and flow of rate forecasts. Having already reached an exceptionally hawkish high, we have seen rate forecasts stabilize somewhat in recent weeks. Naturally, the 2-year Treasury yield and Fed Funds futures also stabilized. As for the greenback, it has been apathetic for a few months. It has long awaited a response – whether due to the lure of higher interest rate expectations or a return to its role as a safe haven. I still view the USDJPY as the most attractive barometer – if not an opportunity in itself – as the dollar’s fundamental engagement is particularly exacerbated by this crossover. I prefer a bearish result, but I will let the market decide.

Chart of USDJPY with 100 and 200 day SMA with 10 day historical range and ATR (daily)

Federal Reserve decision strategy for the dollar and global markets

Chart created on Tradingview Platform

Remember there is more than the Fed

As I join the crowd in assessing the Fed’s policy decision and charting my trade plans from its decisions, it’s important to remember that this isn’t the only game in town. There are other systemically important themes that lurk just below the surface and easily surface with future event risk. In the same vein as the Fed, the Bank of Canada (BOC) rate decision is expected ahead of its US counterpart; and the rate forecasts are even more sensible for this central bank. It is easier to disappoint here if the market expects such an outcome. Choosing crossovers that play well against, I will avoid the USDCAD for crosswinds and pay more attention to the NZDCAD pushing new lows. Earnings is another theme of merit. Microsoft beat expectations after hours on Tuesday, but the stock failed to recoup lost ground (having closed below its 200-day moving average for the first time in 463 trading days). Tesla’s after-hours update on Wednesday carries even more weight with the Reddit board crowd, and Apple’s Thursday night report will be the most important metric for the season.

Calendar of key macroeconomic risk events for Wednesday and Thursday

Federal Reserve decision strategy for the dollar and global markets

Calendar created by John Kicklighter

Growth is another theme that has blown a chill through markets this week, but has probably yet to exert its full influence on investor conviction – when major event risk is ahead, it can mitigate both good and bad titles. Yet, after the Fed makes its announcement and becomes engrossed in traders’ intentions, we will have to reconsider the serious downgrade of the IMF’s global outlook (4.4 vs. 4.9% of GDP) and falling PMIs. from January to Monday. If that’s not enough, then perhaps the likely deceleration in Thursday’s Q4 US GDP update will drive the situation home.

IMF World Economic Forum Economic Forecast Table

Federal Reserve decision strategy for the dollar and global markets

IMF WEO January Update Table

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