Market shakeout yesterday is a preview of what’s to come

Dec 10, 11:30 am
Market shakeout

With the countdown to the US FOMC meeting due in less than a week, the markets got a glimpse of volatility yesterday as the US Dollar sold out strongly into yesterday’s close since the start of the US trading session. If yesterday’s price action is anything to go by, traders should expect the extreme volatility to keep up into the Fed’s interest rate decision next Wednesday, December 16th.

The US Dollar Index fell -1.07% yesterday closing at a 24 day low on a day lacking any clear fundamentals. The declines came about after last Thursday’s ECB’s meeting where the Euro rallied strongly leading to a weaker US Dollar Index which fell -2.10% for the day. The price action in the US Dollar shows the institutional money squaring off their US Dollar long positions and understandably so.

While for the most part of this year, the markets were focused on ‘IF’ the Fed would hike rates, with the October and November jobs report posting strong growth in the US labour markets, the markets are very convinced that the Fed is on track to hike rates, with the exception of a catastrophe in the next 6 days that would limit the Fed to hiking rates. Looking forward, no one knows how the markets are going to react as the US Federal Reserve looks to hiking rates in nearly a decade. In fact, most retail traders haven’t even witnessed a US rate hike which simply reflects the uncertainty that lies ahead.

With the Fed funds, futures rates now implying a more than 80% probability of a 25bps rate hike, the question to ask is how the Fed will guide the markets going forward. More importantly, the markets will be looking at the scale and speed of the rate hike cycle from the Federal Reserve, which in all honesty will be a tough choice to make. Janet Yellen will be asked on taking a balanced approach which is to calm the markets while the Fed continues to lift off the decade-long Zero Interest Rate policy.

The US equity markets, which is the first to feel the effects of an interest rate hike cycle has been range bound since the past 7-weeks, trading within the 2100 – 2020 high and low. On the same note, the 10-year Treasury note has been trading near 2.20 and remains well supported above 2.00 – 1.90 support.

How can retail traders position themselves into the FOMC Decision next week?

For the average retail trader, the best advice is to take a break and stand aside from the markets until after the dust settles with most of the Forex markets likely to remain very choppy. Traders should avoid USD crosses as much as possible if they are unsure on their positions or their trading strategy, which could be put to the test as well. For traders who are looking to trade the currencies, it would be best to trade the short term ranges rather than look into building positions over a period of time.

Gold and silver are the two commodity plays which are more likely to weather out the Fed’s decision with Gold, known as a hedge against inflation likely to rise eventually.

The Yen is also likely to strengthen into the FOMC meeting as the looming uncertainty will keep the Yen as a favored safe haven currency followed by cross currencies such as AUDNZD being the only safe trades worth mentioning. Given the large weight, the Euro has against the US Dollar Index, it would be best to avoid the Euro as well which will eventually get dragged into the volatility next week.

No matter what markets one trades, focusing on risk will be no doubt of utmost importance.

The US Federal Reserve will be meeting on December 16th, 2015 at 0700 UK time with expectations of a 25bps rate hike.

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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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