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There is nothing more volatile on the currency calendar right now (or on any financial calendar for that matter) than the Federal Open Market Committee (FOMC) meeting this week.
This is going to be followed by what is expected to be Ben Bernanke's last press conference as the Fed Chairman before his anticipated retirement in January 2014.
And let me tell you: Someone is going to be surprised this week. The good news is, surprises create volatility. Volatility creates price action. Price action creates profits.
You see, a chart of Reuters economists shows that 44% are looking for this week's FOMC meeting to end with a taper (the beginning of the reduction of the economic stimulus) announced for March 2014. About 27% expect a taper in January; and 22% expect a taper this week. (We are not among that 22%, for these reasons…)
There is no clear consensus on the taper timing.
However, when a taper doesn't happen this week, those who have readied for one will be forced to cover their positions – while the rest of us profit.
And a huge move will be in currencies… Take a look.
FOMC Meeting This Week and Currency Trading
The weeks before last September when the QE taper was first thought to come to pass show that the euro strengthened in that time, and the U.S. dollar weakened.
The market is betting that a taper will hurt the U.S. economy, and benefit the euro against the dollar. In fact, the euro has been rising the whole time taper talk has progressed – except when the European Central Bank (ECB) cut its main rate in November.
So the only thing that has weakened the euro is its own bank.
Even though we did get a technical break down last week in the euro, we got no follow through because of "comatose" market conditions.
But this EUR/USD pair isn't the best bet for currency trading after the Fed meeting this week.
Remember, in currency trading, you always want to pit the strongest currency against the weakest. And that isn't just measuring what is currently happening, but what is expected to happen of the near and intermediate term.
With that in mind, take a look at the USD/JPY chart below.
The U.S. dollar has been beating up on the Japanese yen in the weeks following a wedge breakout. And this has accompanied talk of the taper. A bullish U.S. dollar response is what we would expect out of this pair, even without a taper happening on Wednesday.
And while the move upward has been measured and cautious, this week could actually change that. With one fly in the ointment…
As I stated above, don't forget the sleepy market conditions. This is not likely to create a lasting trend into the next holiday in the New Year, as there simply isn't enough participation. But it might create enough volatility for a good trade.
The short term volatility in forex markets is the highest it's been since August when taper speculation began running hot. However, longer term volatility is the lowest it's been in a decade, signaling that market participants aren't really expecting much to happen. Neither do we.
Lastly, I do have a greater expectation of volatility in the USD/JPY cross because of the Bank of Japan rate decision due on Friday. Even though I expect no movement on rates from the BoJ, we may get to see a further discussion for the plans to implement stimulus in the first quarter of next year.
With a taper delayed until 2014 at the soonest, and a continued weakening yen outcome on Friday, we could see these two events team up for a very nice long USD, short JPY trade.
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