Federal Reserve officials will spell out, for the first time, how they expect short-term interest rates to move for the next three years—a move that has the potential to jolt the foreign-exchange market over both the short and long term.
The release of the forecast, scheduled for Wednesday, after a meeting of the central bank's policy-setting committee, isn't expected to include surprises about interest rates. Market participants expect the outlook will show rates are likely to remain at low levels until at least late 2013.
But over time, they say, the forecasts could inject new volatility into the dollar's movement against other major currencies. The concept of a rate outlook from the Fed, which historically has been tight-lipped about its plans, is also so new that it could give the dollar a jolt Wednesday, market participants said.
"There is in fact going to be so much information…that the risk of confusion and volatility hangs over the unveiling," said Sassan Ghahramani, chief executive officer at SGH Macro Advisors.
The market is on watch for any hint from the Fed about the potential for a new round of bond purchases, known as quantitative easing, intended to drive down long-term interest rates and boost the economy. No such announcement is expected Wednesday.
"Given this is really the first meeting they're rolling out the new tool, I'd be incredibly surprised if they do anything else," said Andrew Cox, foreign-exchange strategist at Citigroup.
However, the central bank could indicate that it will pursue more easing in the future, despite improving U.S. economic data. In that case, the dollar would weaken as traders adjust their positions in anticipation of bond buying at a later date, said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. Market participants have increasingly been discussing the possibility of another round of quantitative easing in recent weeks, Mr. Esiner noted.
Currency traders are still likely to keep one eye on the unfolding deal to restructure Greek debt as well. Market participants say the negotiations remain a wild card that could further buoy the euro, which has been on an upswing, or send it back toward the depths it hit recently. Earlier this month, it touched a 16-month low of $1.2624 against the dollar.
The euro traded at $1.2931 late Friday, from $1.2969 late on Thursday.
On Friday, Greece and its private creditors were nearing an agreement on a deal to write down 50% of the face value of the country's debt by swapping existing bonds for new bonds with longer maturities and lower interest rates. On Saturday, however, the talks appeared to stall as Germany and the International Monetary Fund questioned whether the proposed average coupon on the new bonds was low enough for Greece to handle over the long term.
Last week, the euro rallied about 2% as the building up of bets against the euro began to abate, the result of progress in Greece's talks with its creditors, as well as successful bond auctions in Spain and France.
"What we're seeing…is extreme euro shorts and extreme euro pessimism is being unwound," Citi's Mr. Cox said. As of Tuesday, net euro short positions—or bets the euro would fall against the dollar—were at a record high, according to the Commodity Futures Trading Commission. The euro closed that day at $1.2736.
But while investors are taking the euro crisis day by day, they'll need to extend their approach to the market years ahead due to the Fed's new transparency, analysts said.
read more: Olympus Wealth Management
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