Trading into the Fed Rate Decision

John Kicklighter
September 13, 2012

We are heading into serious event risk - the kind that not only amplify volatility on dominant themes (risk trends) to dangerous levels, but could also restore direction across the markets. I've been waiting for a serious piece of event risk like the Fed decision to put the market back onto pace; but it is extremely important to trade it properly.

I've written a few reports on the implications and trading approach I am taking into the event. The fundamental backdrop can be found in the Daily Fundamentals, some of the more important charts can be seen in the Infographic article and I list out my ideal pairs for the different scenarios in the Daily Video.

For exposure heading into the event risk, I'm not trying to bet out the outcome of the Fed decision and how the market will interpret it. Therefore, I only have exposure that has a low risk sensitivity and isn't in the direct line of fire. I have my long GBPCAD from (an average entry of) 1.5640. I am taking half off soon around 1.5750 and could add on a break of 1.5780. Then there is the EURGBP long (still a small sized position as my second entry wasn't hit) from 0.7990. There is plenty of room for this to move depending on the break in the euro-crisis we have.

As for trading the volatility and potential trend generation, there are a glut of options (which I list out in the video and will mention in the live coverage). However, for the scenario of no QE3 (a disappointment for risk and booster for the dollar), I like: USDJPY ranging back up toward 79 and perhaps beyond, EURUSD reversing back below 1.2800, AUDUSD dropping below 1.0440, GBPUSD below 1.6075 and EURCAD rallying above 1.2650.

On the opposite end of spectrum (beating stimulus expectations and bolstering risk / weighing the dollar), it is difficult to find pairs that are still relatively undervalued on such an outcome. It is also difficult to determine what such a scenario would look like (most likely an open-ended or very large program). I like for that scenario GBPUSD above 1.6150, NZDUSD above 0.8225, AUDJPY above 81.75 and EURAUD below 1.2250.

For a middle-of-the-road (most likely) outcome, we have to play it by ear. I still think a EURUSD and AUDUSD reversal would be eventual outcomes and would keep a close eye on them.

It is important that the fundamentals support the moves and that this happen quickly (it's not meant to take days for these developments to be fulfilled). Since this is a high volatility scenario driven by a common theme, correlations are likely to be high, so I have to pick and choose from these different options.

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