| The FOMC: Setting the Newest and Hottest Forex Trends |
 Eight scheduled times per year, the United Stated Federal Open Market committee (FOMC) drops a nuclear bomb on the Forex market: the Federal Funds Rate. The Federal Funds Rate is the interest rate at which banks can borrow and lend balances held at the Federal Reserve Bank in New York City.[1] This news release is the primary driver of all Forex investment and speculation. The higher an interest rate, the greater the return for the lending party. Higher interest rates means that borrowing money becomes more expensive. A high interest rate may deter an investor from borrowing money due to the increased cost basis. The FOMC will raise the Federal Funds Rate during strong economic phases to deter excessive borrowing and speculation. This type of FOMC action has been referred to as “hiding the punch bowl at the party” and “maintaining a hawkish tone.” Too much borrowing (aka risky behavior) creates market bubbles, hyperinflation and ultimate collapse. To the Forex investor, a FOMC rate hiking policy equates to a stronger Unites States Dollar. By investing in United States backed securities, the investor becomes a lender to the the government. The higher the Federal Funds Rate, the higher guaranteed return for their loan. Additionally, a rate hike conveys to the Forex investor that the Unites States' economy is strong, and this will spark further investor confidence in all assets pertaining to the United States Dollar. Conversely, lower interest rates are designed to create demand for risk so that the economy can grow. During recessionary economic cycles, the FOMC may elect to cut interest rates to spark growth and spending. This type of FOMC stance is often referred to as “accommodating” or “dovish.” A rate cutting policy generally weakens the United States Dollar, as the return for US investment is reduced. Global investors will likely look elsewhere for higher returns. Trading the FOMC Federal Funds Rate news release in the Forex market is not so cut and dry. For one, the volatility spikes can be potentially account-fatal to the leveraged trader. Second, the market typically “prices in” a rate hike or cut because the FOMC makes their rate decisions based on economic data releases every investor can view. What sparks the volatility and shifts in sentiment are the words the FOMC Chairman uses in the press conference after a Federal Funds Rate decision. Each chairman has developed their own vernacular to communicate the FOMC's thoughts on the health of the economy to investors. For example, current chairman Ben S. Bernanke has included the term “extended period” when referring to the low Federal Funds rate. Therefore, trading the Federal Funds Rate news release is less concrete analysis and is more guesswork on how the Forex market might react to the presence or omission of specific phrases. Source: www.federalreserve.gov/monetarypolicy/fomc.htm [1] |
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