How to read the Forward Guidance about the Federal Funds Rate (part one)

Investors and traders use the Federal Reserve’s forward guidance about its future monetary policy for their trading strategies, as the guidance influences forex markets. In the aftermath of the 2008 Global Financial Crisis, for example, the Fed used forward guidance to support U.S. economic activity and a return of the inflation rate to the 2.0% target. The list that follows summarizes several examples of the FOMC’s guidance about the future path of the federal funds rate, as communicated through its post-meeting statements. For each example, we write how the statement should be interpreted by traders (“dovish” or “hawkish” tone) and the effects on the EURUSD exchange rate. It is a good exercise for traders to learn how to trade the forward guidance in a profitable way soon after FOMC’s meetings.

December 16, 2008: The FOMC lowers its target for the federal funds rate to a range of 0 to 1/4%, which the FOMC considers to be an effective lower bound. In addition, the Committee states that “weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” Dovish, EURUSD rises, ceteris paribus.

January 25, 2012: The FOMC replaces “at least through mid-2013” with “at least through late 2014.” Dovish, EURUSD rises, ceteris paribus.

September 13, 2012: In conjunction with the announcement of its third large-scale asset purchase program (“LSAP3”), the FOMC states that it “expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” In addition, it indicates that exceptionally low levels for the federal funds rate are likely to be warranted “at least through mid-2015.” Dovish, EURUSD rises, ceteris paribus.

December 18, 2013: The FOMC announces it “likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2%, especially if projected inflation continues to run below the Committee’s 2,0% longer-run goal.” Dovish, EURUSD rises, ceteris paribus.

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