FOMC Events: How the Fed Affects Forex
Interest rates are often quoted as the asset class that can influence all other asset classes, and the FOMC has the ability to influence interest rates greatly at their periodic meetings.
The question of whether the FOMC will hike, cut, or hold interest rates unchanged in the US can make waves in everything from stock markets to foreign exchange (forex).* Get ready for the next big event by understanding the inner workings of the FOMC.
What is the FOMC?
FOMC stands for Federal Open Market Committee – a twelve-person group consisting of the seven Federal Reserve Board of Governors members plus five Reserve Bank presidents. The committee meets eight times per year, though can call impromptu meetings, to set the Fed Funds Rate and comment on the state of the economy.
What interest rate does the Fed control?
The FOMC can change the federal funds rate – the overnight rate at which financial institutions allowed to accept cash deposits from consumers borrow from and lend to each other to maintain reserve requirements.
Though it might seem relatively insignificant at first blush, the fed funds rate is seen as a benchmark throughout the entire bond market of the US and abroad. Changes made by the FOMC can have sweeping influences over how debt of all varieties operates.
What interest rates does the Fed influence?
Activity by the FOMC directly influences US interest rates starting with the US Treasury market and ranging all the way to interest rates consumers pay on credit cards, car loans, and home mortgages. Since the Fed primarily affects an overnight rate, it most directly influences short-term interest rates like that of the 1-month Treasury Bill or the 2-year Treasury Note; however, this influence extends, to a somewhat diminished degree, all the way to 10-year Treasury Notes and 30-year Treasury Bonds.
A hike of 0.25% by the FOMC, for example, would likely influence these interest rate benchmarks to increase by a similar proportion, while a cut would have the opposite effect.
US Treasury Interest Rates
Above, US interest rates from the Treasury are depicted for the period during which the FOMC hiked interest rates from 0-0.25% to 4.50-4.75% – occurring from March 2022 to February 2023. While each duration of interest rate digests FOMC activity in its own way, the general trend of US Treasury rates from 0% to around 5% can be seen across the yield curve.
How does the Fed affect forex markets?
Forex markets can be volatile around FOMC events owing to the influence interest rate markets have over exchange rates. Theoretically, higher interest rates in one region versus another can cause flows into the former’s currency for the higher rate; this could cause an appreciation in the first region’s currency relative to the latter’s thus affecting the exchange rate.
Though it’s rarely a one-for-one relationship, there is a historical correlation between one region’s interest rates increasing by a greater extent than another and the former’s currency appreciating relative to the latter; the opposite relationship can also exist whereby if a region’s economy is functioning poorly and requires lower interest rates, then their currency might decrease in value relative to those of less hindered regions.
The USD/JPY forex pair above shows the price fluctuations between US dollars and Japanese yen in the same period during which the FOMC increased their rates by more than 4% and Japan’s FOMC-equivalent, Bank of Japan, held their rates unchanged at -0.1%. In this time, USD appreciated more than 10% against JPY.
How to trade FOMC events using forex
- Choose the forex market you’d like to trade (usually including USD)
- Open an account to get started, or practice on a demo account
- Choose your forex trading platform
- Open, monitor, and close positions**
FOMC meetings are viewed as binary events where the data and information released can be cause for great volatility across many markets, including forex. As a risk management strategy, traders tend to exit a portion of their positions going into the event in an effort to lighten the direct risk it might have over longer-term ideas. Also, this strategy can free up more capital for the actual trading of the event.
The same mindsets – trend following or contrarian – and analyses – technical or fundamental – that are applied to other economic events or general price activity can also be applied here. Traders should, however, recognize that FOMC events can be more short-term and volatile in nature than other trading days.
*tastyfx US is a forex provider that does not grant access to stock trading
**Forex trading involves risk of losses that could exceed the initial size of the account
This information has been prepared by tastyfx, a trading name of tastyfx LLC. This material does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. You should not treat any opinion expressed in this material as a specific inducement to make any investment or follow any strategy, but only as an expression of opinion. This material does not consider your investment objectives, financial situation or needs and is not intended as recommendations appropriate for you. No representation or warranty is given as to the accuracy or completeness of the above information. tastyfx accepts no responsibility for any use that may be made of these comments and for any consequences that result. See our Summary Conflicts Policy, available on our website.
