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The answer to the question above depends on the outcome of the event: In case of a dollar-bullish outcome, vulnerable currencies should be traded against – this will result in stronger moves. In case of a dollar bearish result, the stronger currencies would be a better bet. And what about an outcome that is in the middle? Here are some answers.

Trading the FOMC is never easy: the market usually takes time to analyze the sometimes obscure statement and pick a direction. This event is special – it consists of both the regular statement and then the first ever press conference by Ben Bernanke. So, things might seem more complicated.

On the other hand, when facing questions from the press, Bernanke won’t be able to hide behind carefully crafted statements. So, currencies will move in real time.

In the FOMC preview, after laying out the background to this event, I listed out three possible scenarios. Let’s see them

  1. A definite Yes,:the dollar will rise as speculations will end. The  hawks will celebrate a victory and the road to future rate hikes will finally be opened, although not so soon. Probability: low. The doves seem in control.
  2. No – a hint of extension: There’s a higher chance of him saying something like “probably not” and that extending the program is possible. This means that he opens the door for QE3. Such an over-dovish policy will result in another plunge in the dollar, as QE3 seemed to be off the table. Probability: Medium. QE3 might eventually happen, but big hints are unlikely to be provided now.
  3. Confused answer: Bernanke will try to avoid a direct answer by saying that  policy will be carefully measured according to the new data  with a trembling voice (as seen a few months ago in 60 minutes) and will be asked about it again and again by reporters. This scenario is also bearish for the dollar. Without a straight answer, the market will assume that there’s a chance of QE3, and this will weaken the dollar. Perhaps not as strong as the previous scenario, but the dollar will still be hit. Probability: high. Confusing language is common at the Federal Reserve.

So which currency pairs will move most in each case?

  1. EUR/USD, GBP/USD: The main driver of the euro, and the pound (at a lesser extent) was inflation. The Euro continues ignoring the upcoming default for Greece and the high unemployment, and moved forward on the preparations for the rate hike, and its realization. Britain hasn’t seen a hike despite much higher inflation, but it’s in the air all the time. The dollar fell against these currencies due to loose monetary policy. If the US begins tightening, these two currencies, the euro and the pound, will have no advantage. So, in such a case, they are likely to fall.
  2. AUD/USD, USD/CAD: QE2 has had a huge contribution to rising commodity prices. Australia exports metals, and has felt rising prices at home as well, with quarterly CPI rising to 1.6%. More QE will push the country to more rate hikes, with its already high interest rate of 4.75%. Canada, which exports oil, will also enjoy such a scenario. More money printing means not only higher oil prices, but also higher demand from the US – Canada’s main trade partner. so, both the Aussie and the Loonie are predicted to be winners in such a scenario.
  3. USD/JPY: In case of a “middle-ground” decision, the markets will shake. Of all currency pairs, dollar/yen has the best reaction – more calm, and within range. If you have to trade the event on a mixed scenario, this pair is likely to provide more sound movements.

What do you think? Are you trading the event?

Further reading: US Default and currencies