How to Trade the Fed Rate Decision—2021 Guide
The Federal Reserve’s interest trade decision is arguably one of the most observed and traded events across the market. USD is the leading currency on Forex, so it makes perfect sense that the impact of the rate decision goes beyond the American economy and ripples out on dozens of other currencies and assets. It’s also worth mentioning that for advanced traders, the Reserve’s decision is mighty profitable. But before you jump headfirst into trying yourself out on the market, let’s take a few minutes discussing how to trade Fed rates effectively.
How to trade Fed rates: what is the Fed rate
Let’s start at the very beginning. The Federal Reserve System—also referred to as the Federal Reserve or the Fed—is the United States’ central banking system. It was established back in 1913 as a step towards unifying the monetary policies across the country and reduce the risk of financial crises, such as the panic of 1907. As time went by, the Fed proved to be more than effective. And the turbulent episodes such as the 1930s’ Great Depression and the early 2000s’ Great Recession led to a massive expansion of the Federal Reserve System’s roles and responsibilities.
One of the Fed’s crucial tasks is to announce the interest rate banks within the United States charge each other when lending funds to the Reserve overnight. This process is essential to maintaining and meeting the strict rules of keeping the local economy in balance. But why is this significant to how to trade Fed rates on Forex and other markets?
Besides keeping internal banking under control, the Fed’s interest rate decision is also utilized as a way to manage the American and strive for a healthy economy. The rate will also serve as a benchmark for bank’s policies on deposits, loans, credit cards, and so on. As a result, any change in the interest rate causes an immediate effect on the financial markets by affecting the cost of USD.
How to trade Fed rates: who and when determines the rate
The Federal Reserve’s main purpose is to conduct policies in alignment with America’s macroeconomics objective—maximum employment and stable prices. Now, as you can imagine, making such decisions is kind of a big deal. To achieve the most optimal solution, the Fed formed their own policy-developing body, the Federal Open Market Committee or FOMC. The Committee consists of twelve members: seven from the Board of Governors and five Federal Reserve Bank presidents.
Each year, the Federal Open Market Committee has eight schedules and several unscheduled meetings, during which they analyze economic and financial development within the country. The culmination of every FOMC gathering is the interest rate announcement that has two possible scenarios: continuing the previous decision or making adjustments. Historically, the change in the rate causes more resonance than when it remains the same. So, the next question, logically, would be: what FOMC uses to evaluate whether the rate needs to be adjusted?
How to trade Fed rates: what causes changes in the rate
As we’ve already established, one of the primary tasks of the Federal Reserve is to keep the inflation rate at bay, specifically—at two percent. Inflation is the number one enemy of any currency, as it essentially lessens the value of money by making products in the so-called basket of goods more expensive. The more things cost, the fewer people will buy them, which, in turn, will negatively impact the economy. Therefore, inflation is the primary decision-making factor for FOMS Fed rate announcements. Here’s how it works.
In the scenario where inflation gets too high, the Fed Committee will very likely increase the rate. When this happens, banks have less money to give out and the consumer borrowing slows down along with demand. Additionally, such improvement can make existing loans more pricey, compelling the debtors to hold back on spending. As the public grows short on money, the products are forced to become cheaper in order to balance out the supply/demand ratio, and the objective of keeping the inflation at around 2% is achieved.
But if the inflation gets too low, it points out the fact that people are spending less, which, as we already know, isn’t good for the economy. The longer this continues, the higher is the risk for the Central bank to face a full-on recession. So, very logically, the Fed will cut the interest rates, allowing banks to give out loans on more comfortable conditions. The public gets more money to spend and the market prices can go back up, driving the economy forward.
As you can imagine, keeping an eye on the inflation rate can play a big role in how to trade Fed funds futures and other rate-related financial instruments. Let’s look back and see clear examples of the rate to inflation correlation through history.
How to trade Fed rates: what can we learn from Fed interest rate history
The current Fed rate makes it difficult to believe that it was ever outside of the near-zero range. However, as we look at the chart, we can clearly see the absolute peak in the middle of July 1981 when the rate was just above 18%. From that point until the start of the next century, the rate went down to about 6%, had a couple of low years during 2002-2003, and stayed around 5% all the way to the 2008 crisis.
The unprecedented global financial crisis was triggered by the immoderate risk-taking by banks in combination with the burst of the American housing bubble. Since the majority of worldwide financial activity is linked to USD, the crisis hit pretty much everywhere. With businesses closing, jobs eliminating, and debt growing, the consumers were spending extremely less than needed to keep the economy afloat, making the Fed take drastic measures and drop the interest rate to nearly zero.
That zero-range period lasted for a while, until mid-2016 when the rate only began to climb up. It reached just about a 2% level only to be hit again by the global pandemic. This time the US government along with the Fed, had a lot more to handle than back in 2008. While the late 2000s was purely about finances, the Covid downturn called for a solution that will both maintain a healthy economic balance and keep people safe. As a result, the Fed rate fell back to zero, and as of now, it doesn’t seem like it will be going up any time soon.
However, as the vaccination begins all over the world, the financial experts remain hopeful and urge traders to pay close attention to both the inflation and interest rates. Because, as we have learned from history staying in-the-know can easily become an excellent asset in how to trade Fed rates. Next, let’s discuss what impact does the rate decision have on various markets.
How to trade Fed rates: what impact does the rate decision have on markets
Interest rates dictate the flow of capital into and out of a country. On paper, cutting the interest rates partially denominates the value of the given government, as with it its economy, compared to others. That’s because lower rates roughly translate into lower return rates on government bonds, for instance. The opposite is true for when the interest rate goes up: the rates of return go up as well.
So, when the rate increases fund managers, pension portfolio managers, global investors, and other capitalists tend to look for solutions to move their assets into the country. It’s quite simple: even a domestic USD holder can benefit from the increase in the rate, meaning that large capital holders benefit thousands of times more. However, the rate impact isn’t measured by the aftermath of the decision, but rather by evaluating the overall anticipation across markets. Expert investors always move their capital one step ahead of major events, including the Fed rate decision. And for the retail investors, it means that starting to strategize prior to the announcement is key to success.
But measuring the markets’ expectations is only a fraction of the deal. If you want to know how to trade Fed rates effectively, you should start by comprehending the gravity of USD’s influence across asset classes and economies. The greenback is often referred to as safe-haven currency, which essentially means that even if the dollar isn’t doing well, there will hardly be any other instruments doing better. Simply put: the state of USD is an economic indicator for the whole world. Although this makes the American dollar analysis a bit more expansive than any other currency out there, USD investors can always be sure that they will profit one way or another.
Now, as we have covered most of the aspects of the FOMC rate announcement and its effects on the international markets, let’s move on to practical advice on how to trade Fed rates, including tips on how to trade Fed funds futures.
How to trade Fed rate decisions
A big part of how to trade Fed trade decisions is grasping the mere basics: the rate cut usually means USD going down, and the rate hike vice versa. We also know that it’s not the actual announcement that matters the most but rather the opinion a market forms in advance. Of course, there is no way to just tune into the minds of professional traders and financial institution managers and see what they are planning to do, but there are still some solutions to assess the market’s sentiment towards a certain event.
To effectively measure how the market feels, you should outline a net of interconnected factors that work in alignment with the Fed rate decision. For example, you can track the decision-making logic of large corporations or central banks, notice irregularities in the patterns, and sometimes even read Twitter of significant financiers, like Elon Musk or Jeff Bezos. While this won’t give you direct suggestions on how to act, you should get a general idea of what is happening to USD both locally and globally. Confused about where to start looking? Enter handy trading tools like the Forex economic calendar.
How to trade Fed rate decisions using Forex economic calendar and news
So far we’ve established that overseeing the market prior to the Fed rate decision is crucial to making a correct announcement-related move. Forex economic calendar can make your Fed rate trading a lot easier. For starters, it has all the exact dates and times for any event that has influence over the currency exchange market. Those include performance reports by companies, indices, and institutions, interest rate announcements, political affairs, and a lot more. Besides having all that data conveniently gathered in one place, you will also get brief historical facts, anticipated moves, the severity of the particular happening, and other stats depending on the calendar facilitator.
Anything you’ll find on the calendar falls under the category of fundamental analysis—the study of the factors that happen outside the market but have an effect on it, nonetheless. The fundamental approach can be mighty effective, especially after you have been utilizing it for a while. However, the mere abundance of options presented on the calendar can be very confusing, as there are simply too many possibilities. Luckily, there is one trick to keeping your focus and continuously making rational moves.
Very early in your trading career, set aside a distinct range of fundamental indicators you are going to consider in your analysis. For instance, since we are discussing the Fed rate decision, the scheduled and unscheduled events that concern the FOMC will become the mainframe for how you structure your trades. Compared to many other reports and announcements you will see on the calendar, the Fed decision happens rather often, giving you plenty of opportunities.
As you progress on your journey, add more events to consider, but make sure not to add too many. Sometimes, accounting for a disproportionate number of factors can blur your vision and contradict the analysis results. Remember, that the market doesn’t always play by the rules, and there will be many unexpected windows for successful trades.
Finally, ensure to have a couple of reliable news sources to keep track of any significant occurrences that could influence your preferred financial instruments. In a lot of cases, your broker will provide a solid flow of news, facts, and learning materials. Your job is to get the most out of it and keep your mind open to new ideas and techniques.
How to trade Fed rate decisions based on volatility
Modern traders have a huge advantage over those who traded fifty years ago, for example. Before the profit was made through an ancient buy-cheap-sell-high method. Now, however, online traders all over the world have an option to benefit not from the specific values of trading instruments but from the rates at which these values fluctuate. And as you probably already know the harder they fluctuate—the better.
Volatility is one of the major drivers of traders’ success. Although long-term investors might not be too keen on chaotic, rapid movement, short-term traders, and especially intraday traders, simply live off it. At first, volatile markets seem aggressive and unapproachable, but as long as you have a strategy in mind and try different methods before finding the one that works for you, you’ll be fine.
One of the best things about contemporary trading tools is the number of built-in functions you can use every day to trade effortlessly. Volatility technical indicators, in particular, play a big part in how to trade 30 days Fed funds futures and other Fed decision-related instruments.
Bollinger Bands is a great volatility indicator that forms a channel based on the current price movement. Depending on how the price interacts with the Bands, traders can evaluate the situation and make their decision accordingly. The most straightforward way to use Bollinger Bands in trading is to look at either of the bands and the 20-period Moving Average in the middle as the levels of support and resistance. This way, when the price hits the middle it will most likely revert back up or down, based on the current trend.
Another approach to how to trade Fed funds futures and other interest rate oriented instruments is through rice action signals, which we will talk about next.
How to trade Fed rate decisions using price action signals
Price action trading, also known as bare-chart trading, is one of the most rudimentary, yet highly effective ways to benefit from Forex and other markets. The general idea behind this method is that the price itself can tell you where it will go next. By plotting the price over time and spotting specific patterns and formation, the traders are essentially able to predict the next move and, consequently, bet on it.
One of the very common price action tactics is finding particular combinations on a Japanese candlestick chart. Candle chart is the most popular visual representation of price movement, as it includes the most information and helps to oversee the market more effectively. Each candle carries the open, close, high, and low price values over a specific time period. Now, a candlestick pattern is a structure of one or more candles next to each other that carries a historically confirmed signal.
Patterns are mainly used to tell whether the ongoing trend will continue or reverse. For example, a Rising Three pattern found in an uptrend is a clear continuation signal. This formation consists of five candles, although sometimes it can have less or more. It begins with a long bullish candle, followed by three (on the average, sometimes, two, or four, or five) short bearish candles. In identifying this pattern it is important to ensure that neither the bearish candles nor their wicks go lower than the first candle’s body. Concluding this formation is another long bullish candle that started within the body range of the last bearish one.
So, if you are going long a Rising Three is your friend in an uptrend, while Three Black Crows are not. This pattern consists of three large bearish candles (usually red or black, hence the name) with lower opens and lower closes than each preceding one. When spotted in an uptrend the Crows let traders know that the bearish pull is serious and it will most likely push the price further down, perhaps, starting a bigger-scale downtrend.
Understanding and learning the candle patterns by heart can be an excellent asset in your trading journey. At first focus on spotting the most common ones, such as an Evening Star or an Abandoned Baby, and, yes, they all have those easy-to-memorize names, slowly making your way to more rare and complex ones. Lucky for you, the financial markets tend to be sort of repetitive, meaning that anything is bound to happen multiple times in your trading experience.
Why trade the Fed rate decision with AdroFx
Today you learned the basics of how to trade Fed rates, so why not go ahead and try this knowledge out? With AdroFx, any trading method and instrument is easy to deal with, because we provide round-the-clock support to all of our clients, tons of handy educational materials, analytical reports, trading signals and a lot more. Once you get more comfortable with understanding how Forex works and how you personally can benefit from it, open a free demo account with us, so you can practice a bit before you start trading for real.
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