What is a Fed Rate Hike?
A Federal Reserve (FED) hike or cut is one of the main market movers in the world. In 2015, the anticipated rate hike by the Federal Open Market Commission (FOMC) led to a significant move in the market: The dollar gained against all the major currencies.
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.
In December, the FOMC pulled the trigger by raising the base rates by 50 basis points. As expected, the dollar rose with the focus being on the future rate increases.
Early this year, the indication was that there will be four rate increases.
Investors positioned their trades in this regard.
This year so far, there has been no rate hike in the United States. In Japan, the BOJ has announced negative interest rates.
This article highlights five key strategies you can use to predict a Fed Rate Hike.
→ What to Watch Out for as the Fed Makes Another Rate Cut
#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.
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
Finally, 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).
#5 - 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.