Does Fed day still matter? Let’s find out
All experienced traders know that markets change their character
periodically, transitioning from trending periods to consolidating ones and from
volatility to quiescence. Less well appreciated is that market moving
events also run their cycles. Those of us that have been around the
markets longer than we care to admit recall a time when everyone waited with
baited breath for money supply reports. I can’t recall trading off an oil
inventory report during my years of trading in the late 1990s; now it is covered
by the financial media as potential market mover.
Few occasions, however, can compare to Fed Day as a market event. It is
not unusual for markets to trade with eerie calm prior to the reports, only to
pick up substantial volume and volatility upon the announcement of the Federal
Reserve’s decisions at 2:15 ET. Such trading interest is spread across
multiple markets, given the relevance of the Fed’s policy stance for interest
rates, currencies, and equities. Little wonder that short-term
traders–those who thrive on intraday volatility–love Fed Day.
Lately, however, their love affair has lost a bit of its luster. Two
factors have conspired to change the character of Fed Days:
1) Greater policy consistency – The Greenspan Fed has approached
inflation with gradualism, avoiding interest rate shocks;
2) Greater policy transparency – The Greenspan Fed has
increasingly telegraphed its intentions in its minutes, again avoiding shocks to
the markets.
Every indication is that the incoming Fed Chair, Ben Bernanke, will adopt
similar stances. “Transparency Wins, Fed Leaks
Lose, With Bernanke” was financial columnist Caroline Baum’s headline upon
the news of Bernanke’s nomination as Greenspan’s replacement. In that
nomination, President Bush praised Bernanke by noting that, “As Fed
governor, Ben advocated greater transparency in communication with the public
and markets.” In accepting the nomination, Bernanke promised,
“…if I am confirmed to this position, my first priority will be to
maintain continuity with the policies and policy strategies established during
the Greenspan years.”
All of this is great news for decision makers whose jobs
will be made easier by a gradualist, transparent Fed. It is not
necessarily great news, however, for short-term traders who have come to rely
upon Fed surprises for exciting trading days.
A review of market action during Fed Days going back to
January, 2003 (N = 22) is instructive. (See Chart below). From
January, 2003 to August, 2004 (N = 13), the average trading range of the S&P
500 on Fed days was 1.45%–well above the average daily trading range of 1.09%
for the entire period of 2003 – November, 2005 (N = 738 trading days).
Since September, 2004, however (N = 9), the average trading range on Fed Day has
been a subnormal .90%. This same pattern of reduced volatility on recent
Fed Days has also occurred in the NASDAQ 100 Index, which averaged daily
volatility of 1.57% from 2003 – 2005. During Fed Days between January,
2003 and August, 2004, the average NASDAQ volatility was a healthy 2.31%.
Since September, 2004, however, the average trading range on Fed Days has only
been 1.14%–about half its earlier level.
To be sure, volatility has been dropping in those
markets independent of any Fed changes. As I outline on my
free research website, however, volatility of Fed Days from January, 2003 to
August, 2004 in the S&P 500 and NASDAQ 100 exceeded volatility of other days
in those markets for that same time period. Since the September, 2004
meeting, however, the volatility of Fed Days has been no different from average
volatility during that same period. In other words, Fed Days have become
no big deal.
Interestingly, the price patterns of Fed Days have
changed as well. During the volatile period of January, 2003 to August,
2004, Fed Days averaged a gain of .47% (10 up, 3 down) in the S&P 500 and
.76% in the NASDAQ 100 Index (10 up, 3 down). This is much higher than the
average daily change of .05% and .08% for the two averages respectively
over the 2003 – 2005 period. From September, 2004 to November, 2005,
however, the average daily change on Fed Days in the two markets has been -.16%
(3 up, 6 down; 4 up, 5 down). Along with the lower volatility, Fed Days
have discontinued a bullish bias.
December’s Fed meeting could still hold the promise of
surprise if there is a change in wording or policy to indicate an end to the
recent tightening policy. If so, we might see a trading pattern more like
that from January, 2003 through August, 2004. To the extent that our new
Chairman makes good on his word, however, we may see Fed Days going the way of
the M3 statistic in their market-moving potential.
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of The
Psychology of Trading (Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for
intraday trading. Brett does not offer commercial services to traders, but
maintains an archive of articles and a trading blog at www.brettsteenbarger.com
and a blog of market analytics at www.traderfeed.blogspot.com.
He is currently writing a book on the topics of trader development and the
enhancement of trader performance.