How Does the US Dollar React To the Upcoming FOMC Meetings?

We have identified the effectiveness of the FOMC “drift” effect in forecasting the US stock market, the metals market and the oil and gas segment. Studies have shown that US indices, stocks, metals, oil and gas are rising 24 hours before FOMC meetings.

Today, we will study how the US dollar reacts to the upcoming FOMC meetings.

Strategy

Opening long positions on instruments: AUDUSD, EURUSD, GBPUSD, NZDUSD, short positions by pairs USDCAD, USDCHF, USDJPY 

• at the opening of the hour, 8 hours before FOMC meetings;
• at the opening of the hour, 12 hours before FOMC meetings;
• at the opening of the hour, 24 hours before FOMC meetings;
• at the opening of the hour, 36 hours before FOMC meetings;
• at the opening of the hour, 48 hours before FOMC meetings.

Closing a position at the end of the hour just before FOMC meetings.

The strategy will be evaluated according to the following criteria:

• The average rate of return reflects the relative change in the quotes of financial instruments in percentage. A positive value of the rate of return indicates the profitability of the strategy, a negative one indicates a loss. 

The average rate of return (R) of a financial instrument is calculated using the formula:

where:

n is the number of trades;

P (%) – the percentage of change in the quote of a financial instrument at the time of fixing a position, is calculated as follows:

for buy positions

P (%) = (position closing price - position opening price) / position opening price * 100%

for sell positions

P (%) = (position opening price - position closing price) / position opening price * 100%

• The total rate of return (TR) is the sum of the profits from all trades. The greater the value of the total rate of return, the greater the profit brought by the signal during its testing period. 

• Maximum drawdown (MaxDD) is the maximum loss in percentage terms from fixing unprofitable trades for the entire testing period. The lower the value of the maximum drawdown, the better the trading signal works.

where:

n – number of trades;

TRn – total rate of return of n trades;

DDn – drawdown at the time of closing the n-th trade;

MaxDD – maximum drawdown.

Analysis of the obtained results

Let's look at the strategy testing results:

So, as expected, the dollar is declining 24 hours before FOMC meetings. The average rate of return of currency pairs is 0.13% with a drawdown of no more than 15%.

The profitability of the strategy with entering the market 36 hours before the FOMC meetings is slightly higher and amounts to 0.15% with a drawdown of no more than 20%.

The dollar reacts less to upcoming FOMC meetings compared to US stocks and indices, oil and gas and metals.

Let's see how the average rate of return of the strategy will change when closing positions after FOMC meetings:

As you can see, the FOMC “drift” effect affects the dollar not only before the meetings, but also within 12 hours after the meetings, and also slightly intensifies 1 hour after the meetings.

Let's compare market exit strategies just before FOMC meetings and 1 hour after the meetings:

With small differences in the average rate of return of all currency pairs, a greater increase in pairs with the dollar as a quoted currency is noticeable when exiting the market 1 hour after FOMC meetings.

The maximum drawdown of instruments does not exceed 20% for any of the considered entries and exits.

The best result has been shown by EURUSD, GBPUSD and USDCHF. Their average rate of return of a transaction has amounted from 0.2% with a total rate of return of about 30% and a drawdown of no more than 5%.

Detailed results are shown in the Appendix:

XLSX (0.08 MB)FOMC currencies.xlsx

See also:

Stock Market Anomalies: The FOMC 'Drift' Effect MarketCheese

Does the FOMC "Drift" Effect Work in the Oil and Gas Segment?

"Drift" of Metals Before FOMC Meetings