How I will trade the FOMC

• InEgoVeritas
• September 21st, 2009

The upcoming FOMC meeting on Wednesday will mostly be a “bond” story. The market is awaiting to see if there will be a change of tone from the present risk aversed bias to a more positive one. In the latter case, the result might be a repricing of the USTs (US treasuries) to take into account a more aggressive timeline for the Fed’s alleged exit strategy and ultimately the start of the rate-hike “season”.

I am of the opinion that the FOMC will move to a more positive bias and my trading plan is based on this outcome.  I expect the USTs to see selling pressures. Those following me on StockTwits already know I have been bearish on USTs for some weeks now. There is a clear dissonance between on the one hand, the stock market, commodities and on the other hand, the bond market. Something will have to give and indeed it might have already started. Have a look at the following Dow Jones CBOT Treasury Index daily chart (a 10 year bond futures and cash based index).

The fact that the 200 dma is acting as resistance and that we had a MACD crossover could be the signal the bears have been waiting for. From a fundamental perspective, we’re expecting $112B of new treasury notes only this week with plenty following up soon. More importantly, the Fed’s treasury-buying programme ends in October. Let’s not forget that the Fed has been the largest buyer of USTs in the second quarter. These events should provide further downward pressures to say the least.

Another sign that things are turning is the US dollar index. The index has been selling with the lower UST yields in the past weeks. The following dollar index daily chart shows a temporary low at the key 76 level. A doji was printed there and now the slow stochastics are turning from overbought. The correction again here seems to have already started.

Now that we know that  lower USTs (or higher UST yields) will most likely be dollar positive, let’s have a look at the currency pairs that are the most sensitive to them. The following chart looks at the relative (% change)  correlation between $jpyusd (reversed $usdjpy), $audusd and the 10 year UST yield since the week of May 14.

The chart tells us that the $audusd tends to trade with the 10 year yield and that the $usdjpy trades against it. Going long the $usdjpy would then clearly be a good strategy if one is looking to go long the dollar.  I will definitely keep an eye on this key pair but I will be looking at taking the fast lane and trade the $audjpy pair to take advantage of both the strength of the Aussie and the weakness of the Yen. Whenever I enter a trade, I always try to trade the strongest currency against the weakest. Better risk/reward is always a winner. Full disclosure here, I am already long the pair. I will however be adding to those longs providing things go as planned.

The following $audjpy daily chart shows how interesting this pair is. It’s been kept below a strong resistance for a few months now but it is up to that level again but this time, it has some major support. Actually it’s not just support, it’s a confluence of supports provided by moving averages, the ichimoku cloud and a 7-month long up-channel.

I think you now have an interesting perspective on the FOMC. You should be able to go away and think about how you will be trading it based on your style and risk tolerance.  As the Romans used to say, Omnia in fine ipsum consilium semper. The plan itself is always everything in the end.

Best of luck to all,
IEV

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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