Fed Watching

The whole financial world is obsessed with watching the Fed, and rightly so, if you can understand where the Fed is likely to go next or at least how the market as a whole is pricing in anticipations about future Fed actions, you have a better chance of being able to identify the future direction of the market.

The whole financial world is obsessed with watching the Fed, and rightly so, if you can understand where the Fed is likely to go next or at least how the market as a whole is pricing in anticipations about future Fed actions, you have a better chance of being able to identify the future direction of the market.

Fed Speak Decoder Ring
“How many central bankers does it take to change a light bulb? Just one. He stands still and the whole world revolves around him”

Fed speak can be difficult to decode at times. Alan Greenspan was notorious for his cryptic style. At a press conference, he was asked the following question:

“Mister Greenspan, are you or do you ever intend to, and if not why not, and if so how and when?“

Greenspan replied:

“Yes and no.“

He later added:

“And if you feel I answered the question, I’m sorry.“

One of the best ways to follow the Fed requires a little bit of home work, but the payoff can be worth it (or at least you will be able to impress your friends with detailed knowledge of the Fed at the pub). Rather than relying on second hand analyst interpretations of Fed actions, actually read the Fed’s speeches. Almost all top fund managers do this and when you listen to them you will hear them refer to specific lines in those speeches.

When reading these speeches look for key phrases that are repeated by several Fed members. When you see a few members collectively repeating a particular phrase nearly verbatim, you can sense that these guys have been tic-tacking on an upcoming policy change.

The next place to look is for a change in stance. Some members of the Fed are characteristically hawkish (i.e. Hawks are wary about inflation and tend to want to raise interest rates when superficial inflation pressures appear or dovish (i.e. doves tend to be more positive about the inflation outlook and generally worry less about the implications of strong economic growth than hawks do). If a member who is characteristically hawkish and suddenly becomes dovish (or vice versa), it is a warning to the market that a change of policy is afoot.

Finally, the other place to look for indications about future Fed actions are in a range of key economic indicators. The Fed either lowers or raises interest rates to control inflation. Interest rate changes work their way through the economy in a variety of ways, beginning with their impact on the three most interest-rate-sensitive sectors in the economy:

Housing
Automobiles
Capital Spending
By looking at these sectors first, you can gauge the effectiveness of the Fed’s interest rate changes as these sectors are almost always the first to be affected.

After analysing Fed speeches and key economic indicators and comparing that against the current market sentiment about future interest rate changes (best done by looking at the treasury bond yield curve), you may have the basis for a trading opportunity. If the market is starting to show faith that the Feds actions are successful then you have a trend trading opportunity. Counter trend trades are possible to pull off when market participants appear to have little faith in the Fed’s ability to achieve its two main objectives of full employment and stable prices. In this case a trader can capitalise on the market’s mistake in trying to fight the Fed.

Don’t fight the Fed
Being oblivious of the Fed’s actions is very risky behaviour, but an even worse sin to commit is to think you can successfully contrarian trade against them. Time and time again traders have tried this, thinking that they know better and the Fed’s policies won’t work, and time and time again they have lost their money. They may be right in the long run, but there is usually enough volatility and uncertainty in the markets around Fed interventions, you can be stopped out or margin called quicker than it takes for you to go down to your corner shop and buy a kebab and a pint of beer.

Macrotactics is a blog devoted to recording a part time trader’s journey into the world of trading currencies. In my day job I work as a manager in an Information Technology company. I live in sunny Queensland, Australia with my wife, a cat and a baby on the way. I have been banging my head on this trading thing for at least 3 years now and the deeper I dig into the topic of trading, the more I realise there is to learn. Trading for me has

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