We have the FED decision next week which will tell us about how the central bank thinks the economy is doing. There will be lots of developments. Let’s understand how this can affect the markets.
Chris Pulver is a full-time trader and Senior Currency Strategist at Market Traders Institute. Check out Chris’ brand new trading system – Master Flex – which he calls the best thing he’s ever created. Click here to see it in action.
In a few days, the Federal Reserve will reveal its last monetary policy and interest rate decision for the year.
Come December 13-14, market participants will want to know if the Fed will raise rates by 0.50 percentage point or 0.75 percentage point – or not at all.
Any development will likely have a large effect on how billions of dollars across the world get invested. Especially in the Forex market, where USD pairs could see humongous volume and volatility – major market move potential.
In times like these, it pays to revisit the fundamentals and have a sound trading strategy to position yourself to target potentially winning setups.
Let’s take a look at the potential effects of a 50 basis point versus a 75 basis point Fed rate hike on the stock & Forex markets.
Interest Rate Hikes and Financial Markets
Going over some basics, when the Fed raises rates, it becomes more attractive for investors to hold onto their money in cash, rather than investing it in the stock market. And as a result, stock prices may decline as investors sell off their holdings which can further lead to bearish market sentiment and a decrease in the overall value of the stock market.
Additionally, a higher interest rate can lead to a stronger U.S. dollar. That’s because a higher rate makes it more attractive for foreign investors to invest in the U.S., which props up the demand for the dollar. As a result, the value of the dollar may increase relative to other currencies.
So, a rate hike can upset the stock market and it can support the U.S. dollar.
However, these effects vary depending on a number of factors, including the pace of rate hike, the overall state of the economy, and the investor sentiment.
Here’s how a less than anticipated versus a more than anticipated rate hike can affect the stock and Forex market:
50 v/s 75 Basis Point Fed Rate Hike
Let’s quickly go over what’s going on with the U.S. economy and the Fed.
The Federal Open Market Committee (FOMC), which decides the course of the U.S. monetary policy, has already delivered four consecutive 75 basis point or 0.75 percentage point rate hikes.
We’ve not seen rates this high or hikes at this pace in decades. Many pundits are likening Jerome Powell to Volcker, who fought inflation as Fed Chair from 1979 to 1987 with historically high interest rates.
The Fed right now is looking to cool down a hot economy to tame inflation.
The October inflation reading in the U.S. stood at 7.7%. The Fed wants to bring it all the way down to 2%. So, it is trying to reduce inflation through what may be its most hawkish monetary campaign since the 1980s. And that explains the outsized 75 basis point hikes we’ve been seeing lately.
But we have seen some positive developments lately. A routine survey by the Fed found that the U.S. economy grew steadily through the fall and inflation eased a bit. The survey, called the Beige Book, painted a somewhat cloudier view of the economy compared to earlier this year.
So, will the Fed lower the pace of its rate hike in the upcoming meeting?
We’ll have to wait and watch how it pans out. It’s important to note that the effect of rate hike on the market depends on its intensity. The market can react differently to different rate hikes.
Less than expected (or a 50 bps rate hike)…
In the stock market, a smaller-than-anticipated rate hike, say a 50 basis point, can lead to a temporary increase in stock prices as investors become more confident in the strength of the economy. However, this effect may be short-lived, and stock prices may eventually decline as the market adjusts to the lower-than-expected interest rate.
As for the Forex market, a smaller-than-anticipated rate hike can lead to a temporary decrease in the value of the USD. This is because the lower interest rate may make it less attractive for foreign investors to invest in the U.S., leading to a decrease in demand for the dollar.
More than expected (or a 75 bps rate hike)…
If the Fed raises rates more than anticipated, say a 75 basis point rate hike, it can lead to increased volatility in the financial markets.
In the stock market, a larger-than-anticipated rate hike can lead to a sharper decline in stock prices as investors sell off their holdings because higher rates can mean more pain for businesses and ultimately the stocks. This can cause a decrease in the overall value of the stock market.
In the Forex market, a larger-than-anticipated rate hike can lead to a sudden increase in the value of the U.S. dollar. This is because the higher interest rate may make it even more attractive for foreign investors to invest in the U.S., leading to an even greater demand.
So, how can one trade this market environment?
Generally speaking, the best pair for you to trade is the one that you are most knowledgeable about and one that meets your trading and risk-reward expectations.
With an upcoming rate hike, we can look out for some USD currency pair setups to target potential profit from the major shifts in the FX markets.
Our top analysts are noticing some exciting opportunities in USD currency pair movements.
You can know more and trade them LIVE in our upcoming webinar by clicking HERE.
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