Today’s Fed report could make the markets go haywire

Every month around this date, the US Federal Reserve reports the minutes of its latest meeting – and the markets are all ears for tonight’s report.

Of course, what traders are waiting for is a sign – and sometimes, it is no more than a wisp of a smoke signal – of their intention regarding interest rates. Amazingly, many analysts spend their lives parsing the often arcane Fed utterances.

Traders are especially keen to have this information now. The Fed Funds rate has been pinned to the floor for the past 78 months (yes, that is no misprint). Traders know that the Fed is desperate to start raising rates.

That is because the US economy is showing signs of life and a bout of inflation is rearing its head again. If rates are held at zero for too long, an episode of high inflation is feared – and the Fed have their target at a 2% rate. They are afraid of being behind the curve – a charge that has stuck the last time they raised rates in a tardy fashion.

But with everyone leveraged up to the eyeballs (NYSE margin debt at record high), rising rates would spell curtains for most asset price growth.

I know that no agency on earth can control the consumer inflation (or deflation) rate, but the majority of market participants don’t know that!  Money managers have a lot to be thankful to the Fed for – after all, it saved their skins in 2008/2009 with ZIRP (Zero Interest-Rate Policy) and enabled them to make massive profits.

Faith in the Fed runs very high – and that is why we need to pay attention to the market’s response to the Fed’s words.

One measure of the utter faith that the Fed will always support stock prices is the current extreme level of bullishness towards stocks.

Below is a chart of the S&P 500 together with the Investors Intelligence Advisors survey:

S&P 500 weekly chart

Chart courtesy of www.elliottwave.com.

It shows that extreme bullishness has been present for almost two years (with a few dips along the way). That level of complacency can only be sustained that long by managers having complete trust (some with fingers crossed) in the Fed.

Will the Dax rally whatever the Fed says?

On Monday, I suggested that the Dax, having fallen from last Thursday’s high of 11,450 to 11,000, could be due a bounce. But the selling was too intense for that and the market fell further – and to a significant Fibonacci retrace level:

Dax spread betting chart

It hit the Fibonacci 38% retrace of the entire rally off the October low – a significant area of support. Not only that, but I can draw in a very pretty tramline pair where the market also hit the lower tramline yesterday. My bounce was delayed, but I did get it.

That was a superb place to take profits at the 10,860 level for a tasty gain of around 600 pips. And that is why the Dax is such a great vehicle to trade using my tramline methods.

That 10,860 level was a superb place to take profits for a tasty gain of around 600 pips. If there is no good setup in one, there may be in the other.

The decline off the April high has the appearance of an A-B-C, and that throws up the intriguing possibility that yesterday marked a significant low just prior to a rally phase. That is because a three-wave pattern is always counter-trend, and with the momentum divergence at the low a rally becomes a quite distinct probability.

Does this mean that the markets will rally today, regardless of what the Fed throws at us?

How to play a major report

With the market waiting with bated breath, I fully expect many markets to become volatile today, and remain so in the near term.

That throws up a dilemma for traders.  Do you enter the report with open positions, or exit all or most of them beforehand, locking in your profits?

That is a tough question and there is no hard -and-fast rule (ias so often in trading).

With extreme volatility comes the high risk that your protective stops will be hit. An early exit would help you keep more profit, which is always desirable.

But there are instances where a report can cause the market just takes off in your direction.  That bumps up your happiness factor enormously.

Most of the time, I prefer to at least lighten up my positions a day or two before the report date, especially if I have a good profit.   That way, I can view the market’s reaction with some equanimity, which would be rather difficult if I held big positions!

I reckon that I can always look for another entry afterwards.  I do not regret having missed out on some profit.

Being in a state of composure is very valuable when all around you are engaged in highly emotional trading.

As I’ve written before, emotional trading is rarely good trading. As my first goal in trading is not to lose money, I don’t enjoy emotional trading.

That said, if you are an adrenaline junkie, you will of course relish the idea of taking positions into the maelstrom!

Horses for courses.