Welcome to Quantra Classroom. Today, we will discuss Federal Open Market Committee (FOMC) Meeting Effect on Stocks.
As a trader, you may have heard that the Fed has increased interest rates over the past year. This decision was made in an effort to counteract the high inflation rates experienced in 2022. Most recently, in the first week of February, the Fed increased interest rates by 25 basis points, or 0.25%. While this is a lower rate hike than those implemented in previous months.
As you can see the history of the interest rate hikes for the past year.
Source: Forbes.com
How does it help in countering inflation?
When the federal funds rate is raised, banks will increase the interest rates they charge for loans and deposits. This makes borrowing more expensive, which can discourage people and businesses from taking out loans, and incentivize people to deposit money in the bank to earn higher interest. As a result, there is less money circulating in the economy, which can help to slow down inflation.
However, raising interest rates can also have negative impacts on the economy, such as slowing down economic growth and making it harder for some people and businesses to borrow money. For this reason, the FOMC carefully considers a range of economic factors before making decisions on interest rates.
As a trader, can you benefit from these types of events?
There is one type of strategy called the FED day effect strategy which can be used here.
Before we talk about the strategy, you should know that FED meetings are planned in advance. And these meetings usually take place for 2 days, with the important announcements being made public on the second day, including the updated federal bank rates.
Based on academic research, there is evidence to suggest that Federal Reserve (FED) meetings have a positive impact on equity markets. Specifically, it has been found that buying the SPY index before the meeting date and selling it after the meeting has ended could be a profitable strategy on average.
If you were to backtest this strategy using historical data, you may find that it has been successful in the past.
The graph shows that if you had invested $1 in this strategy in 1993, it would have returned $1.85 by February 2023.
Now, you might think that this performance is abysmal. But you must understand that you are allocating your capital for a few days in a year only. And with the maximum drawdown of 8.5%, your risk is very low.
Thus, while it looks like a low-return strategy, it is also a low-risk strategy which gives you optimum performance. Not to mention, your capital is not locked in the market for months.
Sounds exciting, right? You can also check if there is an impact on the performance depending on the number of days before the meetings you have bought the index.
The FED day strategy is just one of many event-driven strategies which can be used to trade today.
You can get the Python code for this strategy from this unit of Event Driven Trading Strategies course on Quantra. You would have to enroll into free preview of the course to access the Python code.
This course contains eight seasonal strategies to capitalize on the anomalies which exist in equities, treasury and volatility markets. You will also learn to use research papers as inspiration to come up with new trading strategies.
Disclaimer:
This post is for educational purposes only and is not a solicitation or recommendation to buy or sell any securities. Investing in stocks involves risks and you should seek the advice of a licensed financial advisor before making any investment decisions. Your investment decisions are solely your responsibility. The information provided is based on publicly available data and our own analysis, and we do not guarantee its accuracy or completeness. By no means is this communication posted as the licensed equity analysts or financial advisors and it should not be construed as professional advice or a recommendation to buy or sell any securities.