What is a Fed Rate Hike?
A Federal Reserve (FED) hike or cut is one of the main market movers in the world. This affected all the major asset classes: Commodities, which are quoted in US dollar had the longest losing streak during the year; American indices, which moved sideways as investors digested the impact of the anticipated rate hike. Instead, the treasuries market faced south.
The Federal Reserve is the most important central banks in the world simply because of the strength of the American economy and the fact that the USD is the reserve currency of the world. Therefore, the market tends to react to all actions by the bank.
A good example of this is what happened during the Covid pandemic. As the pandemic was starting, the bank decided to lower interest rates and then start a program known as quantitative easing (QE). QE is a period when the Fed decides to print trillions of dollars and then invest them in the market.
Therefore, while the world went through a major challenge during the pandemic, stocks, cryptocurrencies, and other assets saw their prices soar because of the actions of the Fed.
At the beginning of 2022, most of the assets that soared during the pandemic declined sharply as the Fed hinted that it will start hiking interest rates. Therefore, you can see the importance of the Fed.
A Fed rate hike is when the bank starts raising interest rates. Ideally, it happens when the economy is doing well. By hiking rates, the Fed is able to reduce the formation of a bubble. It also provides itself tools that are necessary in case of another crash.
This article highlights some key strategies you can use to predict a Fed Rate Hike.
How to predict a FED Hike
#1 – Study the Local Market
A rate hike increase happens when the market is doing well. One of the reasons why the rate is hiked is to slow down the economy.
An economy that is growing very fast puts investors and the residents at risk in cases of correction. For instance, assume you run a lemonade stand that serves 10 clients per day.
In a certain week, you get 25 clients per day. Since you can’t serve all the clients, you take a loan from a local bank to finance the operations. The following week, you get 50 clients per day. The following week, things start changing and your clients starts to decline from 50 to 10 clients. You will now start to have financial difficulties paying back the loan.
This is exactly what the Fed tries to prevent when making a hike.
As a trader, you need to study the local financial market carefully to make a prediction whether the market is growing or slowing.
#2 – Study the Global Market
After looking at the local market, consider the global financial markets and its recent performance.
The Fed will likely hike when the global financial system is stable. You should however look at the main countries and areas. These include Japan, China, Canada, Australia, and the European market.
In 2015, the FOMC delayed the rate hike following the continued decline of the Chinese economy. In 2016, the commission delayed the hike because of the concerns that United Kingdom was going to leave the Euro Zone.
In April (still 2016), the commission failed to hike partly because Japan was in the negative rate territory.
Therefore, it is important for you to consider the global financial system trends when predicting the future rate hikes.
#3 – Use the Fed Funds Futures
Another useful strategy to predicting the future decisions by the Federal Reserve is the Fed Funds Futures contracts. This information is constantly referred to in the financial media because of its intense significance in making financial decisions.
The futures. which contract size is $5 million, are traded in the CBOE (Chicago Board Of Trade) and are settled in cash.
As a trader, you can use a number of Fed Funds Futures strategy to make the prediction. For instance, if the market participants predict that the rate will change, the price of these futures will adjust accordingly.
#4 – Avoid experts
Ofter, you will see experts all over the financial news channels. Some of them are Nobel winning economists!
Bloomberg is fond of bringing in many economists such as Noureal Roubini, Mohammed El-Erian, Paul Krugman, and Robert Shiller among others. Also, major publications such as Financial Times and wall Street Journal constantly write op-eds with major economists who predict the Fed decision.
Most of the time, these experts are usually wrong.
We advise you to listen to their sentiments but avoid them (this is one of the mistakes you always have to avoid). Or, at least, avoid to follow them blindly.
#5 – Key economic data
The next important thing to predict a Fed hike is to study key economic data in the market. The most important numbers to look at are inflation and employment because they form part of Fed’s dual mandate. The mandates ask the Fed to ensure that the unemployment rate is low and the labour market is tight.
On inflation, the key data to watch are the consumer price index (CPI), producer price index (PPI), and the personal consumption index (PCE). The latter is the most important inflation gauge according to the Fed.
The US publishes its employment data every first Friday of the month. It then publishes the PPI and CPI a week later.
Therefore, if the two numbers are doing well, there is a chance that the Fed will start considering more rate hikes. If the situation is worsening, it increases the possibility that the Fed will embrace a more dovish tone.
#6 – Read the Previous Minutes & Follow the Committee Members
A bonus point is to constantly read the previous Fed meetings. This will help you to identify the gaps on why they didn’t hike or why they hiked.
After doing this, you will be at a good position to analyse the current situation and correlate it with the real market situation.
You should also listen carefully to the sentiments of the Fed committee members.
External resouces to understand the Fed Rate Hike
- Read more about Fed Rate Hike on Reuters
- Discover more about Fed Rate Hike on MarketWatch
