Many studies have examined the influence of the Federal Reserve’s unanticipated target rate decisions on U.S. asset prices. Despite the vast and growing empirical evidence on the financial market effect of monetary news released on FOMC meeting days, little is known about the real-time response of U.S. asset prices to the information originating from central bank minutes. A currency’s interest rate is probably the biggest factor in determining the perceived value of a currency. So knowing how a country’s central bank sets its monetary policy, such as interest rate decisions, is a crucial to forex traders.
Currencies rely on interest rates because these dictate the flow of global capital into and out of a country. They’re what investors use to determine if they will invest in a country or go elsewhere. The higher a country’s interest rate, the more likely its currency will strengthen. Currencies surrounded by lower interest rates are more likely to weaken over the longer term. The main point to be learned here is that domestic interest rates directly affect how global market players feel about a currency’s value relative to another.
The FOMC decisions on interest rates are a major indicator for the US currency and are therefore vital for forex traders to take into account when placing their trades. Being aware of the scheduled dates for FOMC meetings and knowing whether there is a Fed meeting on the day allows investors to be prepared for the inevitable volatility that will occur in the markets, and to incorporate this knowledge into their trading strategy at that time, whether they prefer to steer clear of the markets until the outcome of the data release is known, or whether they prefer to take the risk of using the predicted outcome to place their trade.
A popular approach for trying to predict exchange rates is the interest rate approach, which analyses interest rate differentials. It is important to know that under the theory of interest rate parity, the expected interest rate returns of a currency will be equalized through speculation in other currencies once converted back to the first currency. Of course, just like with other theoretical approaches, currencies can violate the interest rate parity theory for a substantial period of time before they meet in equilibrium.
Each Federal Reserve announcement can be a potentially high-impact event on the markets, and traders should prepare for high volatility during these announcements. Traders should be aware of the current situation in employment levels, inflation rates, and economic growth, as the Federal Reserve considers all three of these indicators when changing and implementing monetary policies. When trading around FOMC meeting dates, traders should also implement proper risk management rules, or entirely stay away from the market, as these events will significantly increase price volatility.