Guide · Central banks
How Does the Fed Affect the Forex Market?
What the Fed is trying to do
The Federal Reserve is the central bank of the United States. Congress gave it two main jobs in the Federal Reserve Act: maximum employment and stable prices, with moderate long-term interest rates as a third objective. The Federal Open Market Committee (FOMC), the body that sets US monetary policy, has defined “stable prices” as inflation of 2 percent over the longer run, measured by the personal consumption expenditures (PCE) price index.
That matters for currency traders because the Fed does not target the dollar. It targets inflation and employment at home. The exchange rate is a side effect of those choices, and often a large one, because the US dollar sits on one side of almost every major currency trade. In the Bank for International Settlements’ 2022 survey, the dollar was on one side of 88 percent of all foreign exchange trades.
The FOMC meets eight times a year. It announces its decision at 2:00 p.m. Eastern time on the second day of the meeting, and the Chair holds a press conference at 2:30 p.m. Four of the meetings, in March, June, September and December, also publish the Summary of Economic Projections, which includes the “dot plot” of each participant’s view of the future policy rate. Minutes follow about three weeks later. You can check the current calendar on the Fed’s own FOMC page, and we list the next decision dates on our daily macro page.
The tools: the rate, the balance sheet and the words
The Fed has three levers that move currencies.
- The policy rate. The FOMC sets a target range for the federal funds rate, the overnight rate banks charge each other. Raising it makes dollar deposits and short-term Treasury bills pay more; cutting it does the opposite. The range and the latest effective rate are shown on our macro page.
- The balance sheet. By buying bonds (quantitative easing) the Fed pushes longer-term yields down and adds dollars to the system; by letting bonds run off (quantitative tightening) it does the reverse. The effect on the dollar is slower and harder to read than a rate change.
- Forward guidance. What the Fed says it is likely to do next. Markets trade the future, so guidance often moves currencies more than the decision itself.
In March 2020, the Fed also showed a fourth role: it widened its dollar swap lines with other central banks so that foreign banks could get dollars during a scramble for cash. That episode is a reminder that the dollar is not just a price, it is the world’s funding currency.
How a Fed decision reaches the forex market
Think of it as a chain with four links. Each link can break, and that is why the same Fed decision can produce opposite currency moves on different days.
Rate differentials. Capital tends to flow toward higher yields, other things equal. If the market expects US rates to stay higher than euro-area or Japanese rates, holding dollars pays more, and the dollar tends to strengthen against the euro or the yen. The yen’s weakness in the period when the Fed was raising rates and the Bank of Japan was not is the textbook example. Look at the two-year Treasury yield rather than the policy rate itself: it is the market’s running estimate of where the policy rate is heading.
Expectations versus surprise. Prices already contain what traders expect. A rate hike that everyone expected can leave the dollar flat or even weaker (“buy the rumour, sell the fact”). What moves prices is the gap between what was priced in and what was delivered or signalled. A Fed that holds rates but sounds more cautious than expected can lift the dollar; a Fed that cuts but sounds relaxed about inflation can push it down.
Risk appetite. The dollar is also a safe-haven currency. When fear rises, investors often sell risky assets and move into dollars and Treasuries, even if US rates are falling. This is why the dollar sometimes rises on bad global news. We explain how to recognise that mood in Risk-On vs Risk-Off.
Real yields and inflation. What matters to a bond investor is the return after inflation. If inflation data come in hotter, the market may expect a firmer Fed, which tends to support the dollar over the short term; but if inflation is rising faster than rates, the real return falls. Our guide to CPI and the stock market covers that data release in detail.
How to read a Fed day
A practical way to approach an FOMC day is to separate four things, in this order.
- The decision. Did the range change? Was it unanimous? Dissents show the direction of the debate.
- The statement. Compare the new text with the previous statement. A phrase added, dropped or reworded is often how the Committee signals a turn.
- The projections and dots (on projection meetings). Is the median path for rates higher or lower than before? Is the long-run rate moving?
- The press conference. The Chair’s answers often reset the market’s first reaction within minutes. The first move in the statement minute is frequently reversed.
Spreads widen and prices can jump on these releases, so many traders reduce size or step aside around them. That is a risk-management choice, not a rule, and it is yours to make.
A note on labels
Words like “hawkish” and “dovish” describe the tone of what the Fed says about future policy, not whether it just raised or cut rates. A Fed can raise rates while signalling that the end of the cycle is near, and markets may call that dovish. Always date-stamp a stance label, because it changes. Our current setting is shown, with its date, on the macro page.
What the Fed cannot tell you
The Fed is only one side of every currency pair. EUR/USD depends on the European Central Bank as much as on the Fed; USD/JPY depends on the Bank of Japan’s stance and on Japan’s own inflation. Commodity currencies respond to global growth and to the price of what their countries export. Political events, fiscal policy and trade flows matter too.
The relationship between rates and the dollar is also unstable over time. In some years higher US rates came with a stronger dollar, in others the dollar fell while rates rose because investors worried about growth or about US government finances. Any rule of the form “rate hikes mean a stronger dollar” will fail some of the time, which is why we treat the Fed as one input to a regime read, not a trigger.
How KriekTrade uses the Fed
In KriekTrade the Fed stance sits beside two other inputs, the market risk gauge and the 18.6-year cycle phase. Together they set the backdrop. A trade setup is only published when it also agrees with the daily trend: buys only when price closed above its daily 45-day exponential moving average, sells only when it closed below. You can see the idea in action on KriekTrade. None of this predicts the next Fed decision, and nothing here is advice to trade.
Sources and further reading
- Board of Governors of the Federal Reserve System, Federal Reserve Act, Section 2A: Monetary policy objectives.
- FOMC, Statement on Longer-Run Goals and Monetary Policy Strategy (2 percent inflation goal).
- Federal Reserve Board, FOMC meeting calendars, statements and minutes.
- Bank for International Settlements, Triennial Central Bank Survey of foreign exchange and OTC derivatives markets, 2022 (US dollar on one side of 88 percent of trades).
- Federal Reserve Board press release, 19 March 2020: temporary US dollar liquidity swap lines with additional central banks.
Charts and diagrams on this page are our own illustrations. Data and facts are cited to the publishing agency; wording and analysis are ours. See the editorial policy.
Risk warning. Trading forex, CFDs, futures and crypto carries a high risk of losing money rapidly, and most retail accounts lose money. For education only; this is not advice. This article is general education written by Tian Kriek of Kriek Institutional Research, the publisher of KriekTrade. It is not personal advice or a recommendation. See the risk warning and disclaimer.