So today was Fed day or more apptly put the day the Fed was talking about rates and the policy outlook going forward. Usually these meetings are little more than window dressing as it seems the street already knows what is going to happen. The most intriguing fact about these meetings is the intepretation of what is being said or also what is not being said. One of the biggest questions I get from traders is what will this mean to the markets, or more covertly what will happen to my portfolio? This is a very logical question as it is our job as traders to manage our portfolios much like a shepherd manages his flock. Like the shepherd not wanting to let a sheep get away from his flock we dont want to let our positions get away from us either. So this week I will attempt to make some sense out of the Fed’s behaviour but more importantly how it can affect one’s portfolio.

The recent meetings of the Fed have been real snoozers from a market perspective. By this I mean that the market has had little reaction to the preachings of Jermone Powell. The major talk has been around the rising inflation that for quite a while was, according to the FED, was non-existent at first and then become transitory after some further questioning. I am still trying to figure out what transitory means? I know what the word means, I am unsure to what the FED means by it? The FED has stuck to their guns in wanting to keep interest rates low and has sang this song repeatly for the a while now. The only thing that would change that tune is runaway inflation and according to their metrics that is not an issue at this point. The other theme from the FED has been the expected post-pandemic growth that they are expecting. They have thrown around some lofty expectations in recent announcements and the market has taken this in stride. The market really hasn’t reacted to these projections and has held a wait and see kind of attitude. The only noticeable market condition has been that the market seems to dry up the few days prior to the announcements and this feeds into that wait and see narrative.

Now onto this weeks meeting, the wait and see narrative was in full in effect. There was some pretty dull trading for the last couple of sessions. The crowd was waiting with baited breath for the almighty Powell to wax poetically about all things inflation and the fact that the recent economic reports such as the last two jobs reports and a couple of other metrics were not as robust as the projections would have us believe. The FED did not do an about face on their previous stance and instead acknowledged that the outlook for inflation this year could take a jump but they reiterated that the inflation is “transitory?” The emphasis on the hawkish stance was more about propping up the USD instead of addressing the other concerns for the economy. This change in stance had a very different effect on the market than the previous meetings and this is expected as the other meetings had almost zero hawkishness to the speech.

Now, that we are up to speed on what happened we can discuss what it means to us traders and what we need to consider when it comes to these kinds of announcements. The FED policy decisions and stance affect the currency which in turn affects assets and other instruments that are normally interlocked to the movement of the currencies. Obviously, the other currencies are most affected but it doesn’t stop there. The commodity space is affected because as the price of the USD rises then those same commodities become more expensive as they are priced in USD and anyone outside the US wanting to buy those commodities must first convert to USD to buy them. There are also the inverse relationships such as gold. When the price of the dollar falls then folks go into gold to save value and when the USD rises the price of gold tends to fall as folks flock to the dollar.

After the FED announcement today the USD took a jump on the hawkish news as the decision to bring forward the planned rate increases is seen as a move to strengthen the dollar which in turn make the other currencies that are keeping rates low or even decreasing less attractive.

So the question begs how to we protect our trades or portfolios from this kind of situation? Well, the best thing to do is to look at the portfolio and see what is most likely to be affected by the change in the strength of the dollar and explore the different relationships. If you look at the indexes today they initially took a dive and then recovered quickly before turning lower. This effect has to do with the FED but can also be a function of where the market is at as a whole. If you look at the chart below you can see that the market put in a red doji yesterday before the actual announcement and this can signal indecision. As well being at an all-time could have set the stage for a pullback regardless of the FED decision.

The reality is that we don’t really know how the market will react to these announcements even though we might have an idea of what the FED will do because even if the outcome is known, the change in stance is likely unknown. The good news is that we can prepare ourselves and our portfoilos ahead of these annoucements and the best way to do that is to review exit plans for trades and understand what positions are most likely to be affected and then building a risk reduction plan would be a prudent move. This risk reduction could be as simple as closing trades that might be subject to affect by the announcement or it could mean adujsting positions to a more neutral stance by bringing the delta of trade closer to neutral at least temporarily until the announcement comes out and the market decifers the news.

The key to good portfolio management is good planning ahead of known announcements or events. This can’t always be done for unknown events but good risk management techniques can prevent disaster from striking your portfolio.

Trade Well,

Coach “Old Money” Holmes