Trading preview of the September 2018 US Fed FOMC meeting

All previews try to lead to one conclusion, what will happen to a market or markets before and after? That’s the crux of it all. Do I/should I buy/sell XYZ?

What’s important when looking at events like this is not what the outcome maybe but what the expectation of the outcome is, and what happens if it’s different. At the moment the Fed trade is probably the easiest to decipher. The Fed’s on a hike path, that’s it pure and simple. There only two points we need to consider for trading this one, and two points that the market is going to move on.

  1. Is the Fed going to fulfil 4 hikes this year?
  2. Is the Fed’s expectation for hikes next year going to change?

Let’s take them one at a time.

4 hikes

That’s been the Fed’s aim, and the market has been relatively happy that it’s going to get it. Except, the market can suffer from serious bouts of loss of confidence. It needs constant reassurance that what it is expecting (and more importantly pricing in), is what it’s going to get. Hence, why good US data has largely been ignored in market moves pretty much all year but bad data (see latest CPI data) is hit hard. It’s also why USD has done very little on actual hike days, because the market was just getting confirmation or what it was expecting. What’s ramping up now is the nerves about getting 4 hikes. It should be a done deal because the Fed hasn’t changed its tune all year, yet the market confidence is suffering because, “What it the economy tops out?”, “What if inflation starts to drop?”, ” What if wages don’t rise?”, “What if the trade wars impact growth?”, what if, what if, what if…? We’re getting near the end of the year and the market needs to know it’s getting 2 more hikes over the next 3 meetings.

The real risk then is not if it gets the 2 hikes but if it doesn’t, so that means not only does the market want a hike this week, it wants that comfort blanket that the 4th hike is going to happen. It’s the clock ticking down that is bringing those extra nerves as there’s next to no room for manoeuvring. The Fed have only hiked at meetings with pressers and the next one (after this week) is not until Dec. While earlier this year hike moves in the dollar were very muted, because of the clock squeeze and rising nerves, we’re likely to get a bit more in the way of a relief rally on a hike. It might not be too big because the market is expecting it but it might steady more of the shaking hands in the room. We’re even possibly seeing some of that last-minute expectation creeping in with this constant bid in USDJPY.

2019 Hike path

Once again, the clock is a factor. There’s really not been that much attention paid to next year so far. What’s the point in thinking about a hike in March 2019 when we’re only 50% through the expected hikes this year? But, we’re grinding down to the end of the year and so the focus on next year will start to increase. This is where the Fed needs to properly manage those expectation for next year. The consensus is for rates to stabilise around the 3% mark, so that’s pretty much 2 more hikes next year (if we get the 4 this year). The market will want its confirmation of this so it can get to pricing it all up. We may only be at the start of the 2019 pricing but it will be a factor in the Fed’s statement and projections, more than it was earlier in the year.

Those are the two main points to watch, making sure 4 hikes are coming and what 2019 will bring.

How do we trade it?

The thinking remains the same as it has all year. If the Fed calm the markets by saying its hike path is on course for this year and next, we’ll likely get some form of relief rally but I don’t expect that to last as it won’t be new news. As ever, the bigger price moves will come on anything that changes the path to one that’s shallower. If the Fed knocks the 4th hike this year, USD is toast. It will be burnt toast if they also lower expectations for 2019. If they merely push a fourth hike into 2019, thus raising the number of hikes next year, while keeping the overall view of rates hitting 3.0% in 2019, that will still bring reactive USD selling but it might not be a full-on dump, and could reverse because they’re just moving the goal posts.

One of the key items to look for is how they address inflation. If they brush off last month’s dip then we’re good to go on the hike path. If there’s even a hint of worry, again, the market will assume that the hike path is in danger and USD will be sold.

As traders we should always try to lean the same way as the market but on events like this, where we know where the bigger risks lie, there’s greater opportunity planning our trades against the market, than going with it. Rewards for the market being right might not be as large as rewards for planning if it’s not. That doesn’t mean we blindly go against expectations by selling the buck willy-nilly, nor that we enter any trades at all pre-FOMC but we look at the tools and strategies we have at our disposal. One of those might be to play sell stops (talking USD) that are placed under key support levels, or buy stops above key resistance levels (GBP or EUR etc). You have to factor in the volatility, so a lower trade size can give you a wider stop to play with. If you go with the market and any run higher in USD, make sure you protect those profits as soon as you can because the charts have shown that the dollar can fall after an FOMC meeting. And, if there’s no trade, accept that there’s no trade and move on to the next opportunity. Don’t also be afraid to sit out if you can’t put together a plan. If you try guessing a trade, then you’re gambling and not trading.

There’s always far more to a central bank meeting than what I’ve detailed above but it’s too easy to get bogged down in the fine print and trying to unravel it all. That’s why we should try and keep it simple. Has the big picture changed, or has it not? Does it mean the dollar goes up or down? Anything else we’ll get in spades by the economists and analysts in the hours after, and then perhaps we can use it to fine tune positions we may already be in.

As always, stay safe if you’re going to trade it and good luck.

Ryan Littlestone

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