Knowing what’s expected in the forex market – The art and science of investing

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Most often it is seen that the options and futures markets offer a clear insight into what can be predicted from the central banks, but during other times it is more of an interpretation and an analyzation of recently occuring decisions made by the Bank of Japan (BOJ) and the Federal Reserve (Fed). These decisions play a clear role in highlighting and emphasising the contrast . In the US, the futures market run by federal funds is another live example of how probabilities and credibility can be taken into account.

The FOMC meeting held in the month of October 2015 featured a hawkish change which highlighted the meeting in December as one where the Federal Reserve could hike interest rates. Before the statement, the implied likelihood of a hike was about 35% but soon it jumped up to 50% and this rise played the role of a catalyst in boosting the value of US dollar. It isn’t just the front month, but the chance of 2 hikes by the end of June 2016 has now increased to 45% from 30%.

As stated in the article “The art and science of knowing what’s expected in the FX Market” by Adam Button, market analysts are warning people that it is vital to be careful about being over-confident and over-dependant on these numbers. There’s a high chance that the Federal Reserve could fail to maintain the set target of the Federal funds during the midpoint of its range. In this case the market predicts that the rates will plummet to the lower portion of the range and all probabilities will be distorted. Button’s article states that “understanding what’s expected [of] a central bank is partly art and partly science.”

The BOJ is an instance where the futures and the options market has no guidelines about what is predicted or expected. With interest rates already hovering at 0.10%, there’s no further room to cut rates. Hence, the officials of the Bank of Japan should now rely on increasing and extending their balance sheet even further. The Forex markets tend to look to economists for more guidance and, as per a survey by Bloomberg, 16-36 analysts are predicting more Quantative Easing (QE) by the BOJ.

However, this probably overstates what the market is predicting. Economists are increasingly unwilling to change their ‘calls’ and the recent commentary by the Bank of Japan has put the blame for low inflation on the different commodity prices and has also forecast a pickup in economic growth as well.

One more final measure that followers and analysts of the world’s Forex markets will have to watch is the clock. The Bank of Japan usually doesn’t have a fixed time when it announces changes to its interest rates; the average time for announcements is ususally 12:22 Tokyo time. When the Bank of Japan eases off, the meetings tend to take a long time and hence, as the clock ticks to 1 pm (Tokyo Time) and beyond, people expect to see the Japanese Yen falling as more QE is priced in.

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