April FOMC Preview: 3 Scenarios for the Fed and Impact on Dollar

In 24 hours the Federal Reserve will announce its monetary policy decision and everyone expects interest rates will remain unchanged. The Fed has done a great job of preparing the market for steady rates but no changes to monetary policy doesn’t mean no volatility for the U.S. dollar.

The reason why the April FOMC meeting is important is because it will help to shape expectations for June. There’s no monetary policy in May so if the Fed wanted to prepare the market for possible tightening, they would need to tweak this month’s FOMC statement. The problem is that the odds of a dollar positive and negative outcome is roughly balanced. With the global markets stabilizing and commodity prices moving higher, the Fed has less to worry about internationally but domestically, growth has slowed. So even though no changes in monetary policy is expected at this month’s meeting, the greenback could still have a meaningful reaction to FOMC based upon the Fed’s assessment of the economy.

Now lets run through the possible scenarios

Scenario 1 – The FOMC statement remains virtually unchanged = Mildly negative for the dollar because it would imply an ongoing split within the Fed and reluctance to raise interest rates.

Scenario 2 – Fed acknowledges deterioration in data and leaves out risk assessment = Dollar Bearish

The balance of risks statement was removed from the last 2 monetary policy statements because policymakers could not agree on the outlook for the economy. So if the risk statement is absent again, the dollar could spiral lower as the market interprets it to mean no rate hike in June.

Scenario 3 – Fed acknowledges deterioration in data but describes it as transitory AND the risk statement returns = Dollar Bullish

If the risk statement reappears and the Fed describes the risks are balanced, the dollar will soar as the chance of a June hike increases significantly. Aside from the risk statement the central bank’s comments about recent data disappointments will also be important. If they say the deterioration is transitory, it will help the dollar.

The following table shows how the U.S. economy performed between March and April

An initial glance shows more deterioration than improvements with consumer spending, labor market activity, inflation, production and trade weakening. However there are glimmers of hope. The rally in U.S. stocks helped to boost consumer confidence as measured by the Conference Board’s report, consumer prices are still moving upwards as gas prices increased. New and pending home sales rebounded and most importantly manufacturing and service sector activity accelerated. With average hourly earnings on the rise, the Fed could argue that the economy will regain momentum in the near future and with prices rising, they need to get ahead of inflation expectations. In other words while the data suggests that the Fed should be less hawkish, they could also find reasons to stick to their plan of raising rates twice this year.

FOMC

About Kathy Lien 236 Articles

Kathy Lien is an Internationally Published Author and Chief Strategist of DailyFX.com, one of the world’s most popular online websites for currency research. Her trading books include the highly acclaimed, Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings (2005, Wiley); High Probability Trading Setups for the Currency Market E-Book (2006, Investopedia); and Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game (2007, Wiley). As Chief Currency Strategist at FXCM, Kathy is responsible for providing research and analysis for DailyFX, the research arm of FXCM. She also co-edits the BK Forex Advisor, an Investopedia.com Premium Service with Boris Schlossberg – one of the few investment advisory letters focusing strictly on the 2 Trillion/day FX market.

Kathy is also one of the authors of Investopedia’s Forex Education section and has written for Tradingmarkets.com, the Asia Times Online, Stocks & Commodities Magazine, MarketWatch, ActiveTrader Magazine, Currency Trader, Futures Magazine and SFO. She is frequently quoted by Bloomberg, Reuters, the Wall street Journal, and the International Herald Tribune and has appeared on CNN, CNBC, CBS and Bloomberg Radio. She has also hosted trader chats on EliteTrader, eSignal and FXStreet, sharing her expertise in both technical and fundamental analysis.

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