eToro – Forex Trading Forum

[djsheckie]

So, if you’ve been following the series of posts on the Federal Reserve you’ll now understand why markets react to interest rate announcements. However, just as important are the events and economic conditions that can change the markets anticipation of the Federal Reserve’s actions.

Trying to predict economic conditions in advance is a very difficult process and using monetary policy to try and regulate the economy is even harder. While it’s certainly not easy o predict what may happen the members of the FOMC are constantly analyzing economic data from across the country in an attempt to gauge where exactly the economy is in the business cycle and what if any monetary policy actions they should take.

[djsheckie]

As discussed earlier, the Federal Open Market Committee has 8 regularly scheduled meetings throughout the year wherein they discuss the current economic conditions and any concerns or expectations of future conditions. These meetings are where decisions on monetary policy are planned and made. Once the meetings are adjourned the committee issues a press release with their decisions.

Of primary interest at this meeting is the fed funds rate which has far reaching ramifications for the economy as well as the markets. That why these meeting are so closely followed by traders, economists and financial journalists. However, it’s not just the announcement of whether the fed funds rate will be changed and by how much but everyone’s also trying to determine if there’s any indication of future rate decisions hinted at in the release.

[djsheckie]

Understanding the speculation surrounding these reports is critical as the markets constantly move in anticipation of what may or may not happen. This means that the markets will either move up and down depending on which way people think the rates are likely to go. While other matters and policies are discussed at the FOMC meetings anything else that is in line with market expectations will most likely have little or no effect on the market. However, if there is anything announced which changes the perception of the markets, or foretells any big changes on the part of the Fed it can cause volatility in the markets as the traders and market participants react.

[djsheckie]

When market participants are caught off guard by a change, or the expected changes don’t materialize it also likely that the markets will be volatile. However, in this case the sudden flurry of knee jerk activity is not a desirable outcome for anyone in the markets including the Federal Reserve. So, in an effort to prevent the markets from being caught completely unawares generally the Fed will make an attempt to signal changes ahead of time. This includes hinting at what their stance is on the current interest rates, and usually by the time the FOMC press release is distributed, the market has already responded to whatever actions or lack thereof the Fed has taken.

[djsheckie]

There are three main ways that the Federal Reserve generally signals its intentions:

1. The first way the Fed signals is by the release of the policy decision after the Federal Open Market Committee’s meetings. Obviously, the announcement of whatever planned changes in the interest rates is a major part of the release but just as and possibly more important is the accompanying statements in which the Federal Reserve will generally include their “bias” on the markets going forward.

Upon reviewing a statement from an FOMC meeting you should be able to see what the bias going forward is for the Federal Reserve. This may include statements like “inflation needs to be monitored,” or “expect it to moderate”. They also come right out and say that “downside risks to growth remain” and that they will “act as needed to address those risks.” These sorts of phrases give you an indication of where they stand and what the Fed is like to do.

[djsheckie]

2. Secondly, you may find clues in the FOMC’s meeting minutes. These are the minutes taken at the most recent FOMC meeting and they are usually released about 3 weeks after the meeting has taken place. You can get a much more detailed and in depth account of what exactly was discussed at their meeting and it’s not unusual for to very carefully study the meeting minutes when looking for specific clues as to any future policy actions.

3. The third method of signaling changes is through public speeches. The voting members of the Federal Open Market Committee will give speeches from time to time wherein they may discuss recent economic events and sometimes the speaker will even signal potential changes in their current bias. These speeches are generally closely followed by the markets, but even more so if they come from the Federal Reserve Chairman since he’s the main voice of the Fed.

Those are the main ways that the Fed chooses to indicate its thought process but traders generally also closely monitor any major economic releases for any clues or further signals that the economy may be taking a different path than is expected.