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The Dollar Ahead of FOMC Target Rate Changes

Last Updated on 10 February, 2024 by Rejaul Karim

The research study “The Dollar Ahead of FOMC Target Rate Changes” delves into the intriguing relationship between U.S. dollar movements and scheduled Federal Open Market Committee (FOMC) meetings.

Authored by Nina Karnaukh, the paper reveals a pattern where the U.S. dollar appreciates before contractionary monetary policy decisions and depreciates before expansionary decisions, shedding light on the impact of FOMC meetings on currency movements.

Moreover, the study demonstrates that federal funds futures rate forecasts are significantly correlated with these dollar movements, showcasing a 22% predictive power.
Notably, a high federal funds futures spread three days prior to an FOMC meeting not only forecasts the target rate rise but also predicts a subsequent rise in the dollar over a two-day period. This predictability is particularly pronounced during periods of elevated FX volatility, as FX traders manage arbitrage risk well in advance of the announcement.

With its focus on exchange rates, monetary policy, federal funds futures, and predictability, this research contributes to our understanding of the complex dynamics between monetary policy decisions and currency movements.

Abstract Of Paper

I find that the U.S. dollar appreciates before contractionary monetary policy decisions at scheduled Federal Open Market Committee meetings and depreciates before expansionary decisions. The federal funds futures rate forecasts these dollar movements with a 22% R2. A high federal funds futures spread three days in advance of an FOMC meeting not only predicts the target rate rise, but also predicts a rise in the dollar over the subsequent two-day period. This predictability is concentrated in times of high FX volatility, as the FX traders avoid arbitrage risk earlier than a few days prior to the announcement.

Original paper – Download PDF

Here you can download the PDF and original paper of The Dollar Ahead of FOMC Target Rate Changes.

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Author

Nina Karnaukh
Ohio State University; Fisher College of Business – Department of Finance

Conclusion

In conclusion, the study provides valuable insights into the relationship between U.S. dollar movements and scheduled Federal Open Market Committee (FOMC) meetings. Through meticulous analysis, the research establishes a compelling pattern where the U.S. dollar appreciates before contractionary monetary policy decisions and depreciates before expansionary decisions, underscoring the influence of FOMC meetings on currency dynamics.

Notably, the study demonstrates the significant predictive power of federal funds futures rate forecasts in anticipating these dollar movements, yielding a 22% R2.
Furthermore, the observed predictability of a high federal funds futures spread three days before an FOMC meeting not only anticipates the target rate rise but also forecasts a subsequent dollar appreciation over a two-day period.

This predictability is particularly pronounced during periods of heightened FX volatility, highlighting the proactive risk management employed by FX traders. With its focus on exchange rates, monetary policy, federal funds futures, and predictability, this research enriches our understanding of the intricate interplay between monetary policy decisions and currency movements.

Related Reading:

Safe Haven Currencies: A Portfolio Perspective

Predictability of Currency Carry Trades and Asset Pricing Implications

FAQ

Q1: What is the main focus of the research study “The Dollar Ahead of FOMC Target Rate Changes”?

A1: The main focus of the research study is to investigate the relationship between U.S. dollar movements and scheduled Federal Open Market Committee (FOMC) meetings. The study aims to identify patterns in the behavior of the U.S. dollar leading up to FOMC meetings and how these movements correlate with monetary policy decisions.

Q2: What pattern does the research reveal regarding U.S. dollar movements before FOMC meetings?

A2: The research reveals a pattern where the U.S. dollar appreciates before contractionary monetary policy decisions at scheduled FOMC meetings and depreciates before expansionary decisions. This suggests that there is a discernible relationship between the anticipated monetary policy stance and the movement of the U.S. dollar.

Q3: How does the study demonstrate the predictive power of federal funds futures rate forecasts in relation to U.S. dollar movements?

A3: The study shows that federal funds futures rate forecasts are significantly correlated with U.S. dollar movements. There is a 22% R2 (coefficient of determination), indicating a meaningful relationship. This suggests that these futures rate forecasts hold predictive power in anticipating the direction of U.S. dollar movements.

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