Central Banks

This Chart Shows how the Market Will Probably React to the Fed

Federal Reserve - Shutterstock photo
Credit: Shutterstock photo

The Federal Reserve’s Open Market Committee (FOMC) concludes their regular meeting today, and will issue a statement, followed by a press conference from the Chair, Jerome Powell. The market will be laser focused on that, and traders and analysts alike will parse the wording of the statement and every word uttered by Powell immediately. So, how should retail traders and investors, those of us who control only our own money, be approaching this afternoon?

Recent history provides a clear answer to that question:

Fed reaction chart

The above chart is for the S&P 500 from the beginning of this year, with the blue arrows marking the days when the FOMC concluded a meeting with a statement and press conference and the white trend lines showing what followed. As you can see, for a few days after the statements on all three occasions, stocks have been weak, but then have quickly turned around. As any financial advisor will tell you ad nauseam, past performance is no guarantee of future success, but there is a clear pattern here. When we look at the reasons why the reaction has been as it has and why it has repeated, it seems likely to happen again.

Fed statements at the moment are exercises in caution. They don’t come out and announce any changes or say definitively when those changes will happen. Instead, they maybe change a word or two to indicate a shift in their thinking. That is understandable for a body as inherently cautious as the FOMC, but it does mean that those subtle wording changes are open to interpretation.

What has happened so far this year is that traders have approached the releases with caution, looking for signs of trouble ahead, and circumstances have pushed their reaction in one direction. Stocks have been at or near record highs each time, with Fed policy being a large part of why that is so. Understandably enough, that leaves traders looking for any hint of a policy change, and then overreacting in the short-term when those hints are given.

The Fed, for their part, has no choice but to keep hinting. They are aware that the current ultra-dovish policies must change at some point. They believe that the increases in consumer and producer prices are a temporary phenomenon brought on by exceptional circumstances, but also know that continuing to pump money into the system with no end in sight risks making inflation a real, lasting problem. What they don’t want, however, is to risk a market collapse due to an abrupt about turn in monetary policy that could itself result in economic weakness.

Their answer to that conundrum has been to prompt a series of mini overreactions by indicating that change is coming each time they release a statement or say anything on the record, hoping that will soften the blow when the actually make a change. Those hints find a willing audience in traders who are nervous anyway with stocks at record highs and looking for an excuse to bank some short-term profit, so every release creates a situation where a selloff is likely.

The thing is, though, they are still just hinting at change, not actually changing anything. The Fed believes that they are on the right path, and that changing course too soon would invite disaster. So, even as they change their language and maybe their long-term rate forecast slightly, they continue to keep rates ultra-low and hand out investable cash every month. As I and others have pointed out many times over the last decade or so, as long as that continues, stocks cannot help but go up and every wobble is a buying opportunity.

So, what we are most likely to see over the next few days is exactly what we have seen all three times this year when the FOMC has met and issued a statement: a period or relative weakness which acts as a consolidation before we move on to yet higher highs. That makes any weakness an opportunity to pick up quality names at a discount, and as long as the Fed only talks about acting, that will remain the case.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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