Last Thursday, I had a discussion with Julie Hyman on Bloomberg TV concerning the Fed.? The Federal Reserve System was created in 1913 to run the monetary policy of the country.? There were three main objectives given to the Bank:
1.??? Maximize employment
2.??? Keep prices stable
3.??? Moderate long-term interest rates
Since then, the Fed?s role has expanded in a number of ways and they now also regulate our banks, provide many other services to financial institutions, to our Federal government, and to foreign banks.? Further, they also conduct economic research and publish the beige book (among other publications.)??
So, why the education you can get from Wikipedia?? It seems that now, more than ever, the Fed has taken on another key role: ?stabilizing our stock market. Though some believe this is a purposeful act, others believe it is an ?unintended consequence.?? But, no matter how it came to be, at this point in time, the Fed?s actions seem to have had the largest role in moving the overall market over the past two years. Let?s look at this in a bit more detail.??
We will leave ?history? and jump to our recent predicament.? Since the financial crisis of 2008-2009, we have been in a nearly zero interest rate environment.? The Fed has been extraordinarily accommodative in an effort to support economic growth.? By doing so, they have made the stock market the main source of achieving ?yield? on your investments. This has supported investment and growth in our stock market, and constitutes part one of the ?Fed put?.? Further, beginning with Greenspan and continuing today (in my opinion), the Fed has ?promised? (implicitly) they will supply massive liquidity to the markets should the market have an extended slide.? ?Thus, part two of the term ?put?, as the Fed is basically promising to cap our downside investment risk in the markets.??
Last month, the Fed made a statement that led investors to believe they might be raising interest rates as early as 6 months forward.? The market took exception to the statement and proceeded to sell off 4.2% over the next couple of weeks.? But last week, the Fed took great pains to effectively retract that statement and make clear the longer term plan was still for an extended period of accommodative rates, and the market applauded.? Thus, the Fed is still in charge and the (now) Yellen put is still in place.??
But, there is another piece to the puzzle that concerns me a bit.? Something Yellen said in her statement early last week, which flew under the radar screen at the time, seems to have come home to roost last Thursday.? Yellen stated that future Fed plans will be ?data dependent.?? On the surface, that seems like nothing new and a bit of an obvious statement.? But, Thursday morning, we had a couple of reasonably minor economic numbers come out that signaled a stronger manufacturing sector and improved employment picture.? The bonds, possibly based on Yellen?s statement, dutifully sold off over a full point.? That is a large move for minor data.? Further, anyone who follows the markets closely knows that each individual piece of economic data is prone to large amounts of bias and inaccuracies.? In fact, in the Fed statement, they mentioned ?weather? 103 times as a source of economic data point bias of late.? So, it concerns me that we now have a heightened state of movement based on short-term, often inaccurate, economic news.? ?
What does that mean to me as a trader?? I believe we may see a bit more volatility in the market in the coming months.? Though implied volatility will generally follow historical volatility as it picks up or falls, this occurs less so on upside moves.? So, we may experience some volatility buying opportunities during rallies, assuming the rallies are strong enough to warrant this action.? I will be on the lookout for them particularly when the VIX falls into the 12 handle, as I have spoken about before.
So, let?s raise a glass to the prospects of more volatility for our options trading and less volatility for our trading returns. ?