A Low-Risk Opportunity To Benefit From The Fed Policy Meeting And The Brexit

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Summary

The US Fed is unlikely to hike rates in June, but is expected to raise rates in the July meeting.

The Brexit referendum and its impact on the UK and the European Union are immense, if the UK votes to Exit the EU.

The US dollar offers a low-risk opportunity to benefit from the two forthcoming events.

This year's volatility across asset classes is giving sleepless nights to the traders. Stocks, oil, precious metals, industrial and agricultural commodities have been all over the place, with sharp falls and an equally sharp rally. Relatively, the US dollar has been calm, trading in a large range of 93 to 100, since end January 2015, as shown in the chart below.

The US Fed June policy meeting

The dollar is likely to remain in focus during the next fortnight. The US Fed's June policy meeting, which had little chance of generating any interest among traders until May, got a boost when the Fed released their minutes of meeting of the April policy. The minutes confirmed that the Fed was serious about raising rates and it could be as early as June.

The dollar jumped and the Fed-Funds future, which was pricing in a single digit probability of a rate hike rose to 26%. Traders adjusted their portfolio and got ready for a June hike.

However, there was again a twist in the tale when the Non-farm payrolls data of May was released. The 38,000 jobs added in May against a forecast of 164,000, was the weakest number since 2010. It made the April's weak numbers of 123,000 look excellent.

To make matters worse, the previous two month's numbers were also revised downwards, which quickly altered the picture. The strong jobs numbers and the recovering economy suddenly looked to be faltering.

As a result, the dollar tanked, giving up many days of gains in just a few hours. The Fed funds futures also dropped their expectations of a June rate hike from 21 % to 3.8%, which currently stands at 1.9%.

The markets quickly adjusted for no rate hike in June. Currently, the markets are pricing in a 22.9% probability of a rate hike in July and a 36.8% possibility of a rate hike in the September policy meeting. Investors believe that the Fed will wait till a recovery in the job numbers before moving ahead with a rate increase.

Some experts believe that there is unlikely to be any rate hike post-September, until a new President gets elected, which leaves only December's policy meeting as the possible opportunity to raise rates.

These fundamental factors are not supportive of a rise in the dollar, however, we must not forget that in a faltering global economy, where Europe, Japan, and China are increasingly easing monetary policy using various tools, the US economy has changed course and is on a tightening path. The inherent strength of the US economy will put a floor beneath the US dollar.

Though a rate hike in June is literally ruled out, the Fed Chairwoman Janet Yellen will leave the market with enough hints that a rate hike is almost a certainty in July, which should support the dollar's slide, if any. Hence, the risk of a breakdown in the dollar is low, whereas the opportunity of a dollar rally is high.

Brexit referendum

The second event, which is giving sleepless nights to the traders is the Brexit referendum. The polls on the outcome of the referendum have been swinging wildly from one camp to the other. The latest polls are giving a marginal edge to the 'Exit' camp, which is troubling the traders because the markets hate uncertainty and the Brexit is full of uncertainty.

The experts are divided over the consequence of a Brexit, the outcome ranges from dire forecasts to a bright future for the UK.

If the UK votes to Exit the EU, as an immediate response, most experts are of the opinion that the Pound sterling will shave off 20% and the Euro will also see large moves because Brexit opens a Pandora's box. Italy, Denmark, France, or any of the other member nations can decide to conduct a similar referendum and exit from the EU. Hence, there will be a turmoil, at least in the near-term and due to that, there will be a flight to safety.

The US economy is likely to be insulated from this event, as the S&P 500 companies have less than 1% revenue exposure to the UK.

Among the various asset classes; gold, bonds, and the US dollar will be preferred by the traders.

However, if the UK decides to vote to remain in the EU, the Pound sterling will see a large upmove. This may encourage the traders to pile on risk, however, as the dollar has not seen any significant buying due to the Brexit referendum, there is unlikely to be a large unwinding in the dollar.

Hence, the next fifteen days provide an opportunity to the nimble trader to profit from the forthcoming events. Traders should use the popular ETF PowerShares DB US Dollar Bullish (NYSEARCA:UUP) to trade this opportunity.

As this is an event based trade, we want to limit our risk. Traders should buy UUP at the current level of 24.5, the stop loss for this trade should be kept at 23.9, and expect to hit a target of 25.5. That gives us a favorable risk-reward ratio of around 1:2 and an opportunity to profit from the two forthcoming events.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.