Countdown to FOMC Policy Release Brings Volatility

Wednesday, 3 November 2010 

The data release that we've all been waiting for is upon us. Finally - in less than 24 hours, the Fed will release its minutes surrounding the monetary policy guidelines that have been set for the next quarter. Most importantly, the decision on whether quantitative easing measures will be employed will be delivered with the announcement.

Forex markets are literally on edge in anticipation of this release. The implications for all crosses with the USD are vast. Essentially, it is not a question of whether the Fed will provide further monetary stimulus or not - but instead what level of stimulus they decide upon. There has been plenty of debate in recent weeks over whether the figure will be conservative - at around $200 billion, or whether it will be on par with the funding curve of the market - at up to $1 trillion dollars.

Our opinion is that the Fed will be concerned about the dilution effect that further stimulus packages will have on the USD.  Obviously, the more money that is printed, the lesser value that existing currency in the market holds. Hence, given that the USD has been caught in a wild down trend these last few months - the Fed risks accelerating this trend if it comes out with a large figure for quantitative easing around the $1 trillion mark.

Alternatively, as we have discussed before, if the Fed comes out with a number that is lower than the market expects - equities could decline rather quickly. That is because Wall Street believes that the markets on the whole need a heap more stimuli to recover from the recent glut in the stock exchange market.

The awkward thing for the Fed is that if they come out with quantitative easing measures on par with what the market expects - which is around about $400 to $600 billion of further stimulus - they risk feeding in to the palm of the market's hand.

By showing that they are willing to meet the market's expectations time and time again (this would not be the first time that they had accommodated the markets wishes), they are essentially setting themselves up for failure in the future.

Why? Because from the market's point of view, further stimulus is always something which is desired. Regardless of the times - banks always want more money to play with. Investors always want a supportive authoritative figure in the marketplace. Households always want a regulator which is able to help out in the toughest of times.

Hence, an "on par" figure would be seen as a figure which was determined by the market as a whole - rather the Fed as an independent entity in the FX and equities markets.