The minutes of the last US Federal Reserve meeting showed that several voting members of the FOMC were open to tapering the current $85 billion economic stimulus package known as QE3. QE stands for quantitative easing which was started by outgoing US Fed Chief Ben Bernanke in an attempt to stabilize the US economy during the Great Recession.
While QE3, as well as the previous two stimulus packages, have artificially kept the US economy afloat and outside of a technical recession, defined as two consecutive quarters of negative GDP, the long-term negative impacts are often ignored. Most traders have grown addicted to the stimulus package and used it as the main driver to buy equities at the expense of the US Dollar which continues to lose real value every day.
The opinions are divided on when, how and if the US Fed will reduce its stimulus packages as the only country before the US which has conducted this monetary as well as economic experiment, Japan from which Bernanke more or less received the idea, has not been able to reduce its stimulus for almost two decades. The US is facing a similar situation.
While minutes showed that there is a willingness to taper with the current size of the stimulus, FOMC voting members have made clear that it needs to be supported by economic data. Another fact which makes tapering very unlikely is the start of Janet Yellen’s term next year as the Chairman of the US Federal Reserve. She has already pointed out that she will not only maintain the current stimulus package, but also signaled that interest rates will not change for a very long time.
3 Scenarios with the current stimulus package, QE3, and how it may affect your forex trades:
The US Fed will maintain its current stimulus – Under this scenario forex traders should be prepared for a continuation of current market behavior. Bad economic news are viewed as a positive sign and the US Dollar will continue to lose value and deteriorate with minor counter-trend rallies which will open great opportunities to short the US Dollar.
The US Fed will taper and reduce its current stimulus – This will send equity markets lower and start a medium-term rally in the US Dollar which could also spark a short-covering rally which will add to gains in the US Dollar. Please keep in mind that there will still be a stimulus intact, just at a lower rate. The rally in the US Dollar will depend on the reduction of stimulus.
The US Fed will taper and increase its current stimulus – This will send a mixed message to all traders and equity markets may sell off heavily and enter a bear market as it would signal that the overall economic situation is far worse than expected while the US Dollar would tumble in a very violent manner. Since Yellen is more dovish than even Bernanke, this step should not be ruled out. A very likely scenario will be a minor reduction down to $75 billion followed by an increase to $100 billion.
The US Federal Reserve has severe issues with communication to financial markets and regardless of which scenario will play out, forex traders should be prepared for a very volatile 2014 and beyond especially when it comes to the US Dollar.