A Volatile Yet Bullish USD Last Week

A Volatile Yet Bullish USD Last Week

It was wild in the foreign exchange markets last week, and the reason for the huge swings were related to the Federal Reserve’s interest rate decision and press conference that followed.

In order to have an idea about what really happened, one can just look at the EURUSD and its reaction to the Fed statement: it jumped more than three hundred pips in less than two hours(!), making last Wednesday the 7th day since the EURUSD had such a large move.

To make things even more confusing, the next day, Thursday, those 300 pips were completely retraced. Furthermore, on Friday markets reversed again, leaving everyone scratching their heads, wondering what was next for the US dollar.

This brings us back to the FOMC (Federal Open Market Committee) statement and the press conference that followed.

The previous meeting saw Mrs. Janet Yellen, Chairwoman of the Federal Reserve of the United States, making a clear statement: the Fed will now hike the interest rate and change its forward guidance.

Forward guidance was introduced in central banking language a couple of years ago with the purpose of offering more clues to the trading participants regarding what a central bank will do, what the action will be, and how monetary policy is going to work. The intention was to avoid large swings in the market and for volatility to be subdued.

However, the recent FOMC meeting and statement we saw this previous week proved that forward guidance is failing miserably. Not only is volatility not subdued, but it came back with a vengeance, even if the Federal Reserve did nothing but change one single word from the previous statement: “patient”.

This doesn’t mean that the Fed is loosing its patience and will raise rates soon. It merely signals a change in forward guidance language, like Mrs. Yellen said they would.

Then why the volatility?

One explanation would be that USD longs were at extreme levels and booking profits was the way to go.

Another explanation would be that Fed was dovish as the lady emphasized that a stronger dollar is hurting exports.

Neither of the above are true, or at least they shouldn’t be. The Fed was doing what it said it would, and USD longs are normal before a Fed tightening cycle. However, make no mistake, the Fed will hike rates this year, sooner and stronger than many think.

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