If you’re a purely technical day trader, you might find the current economic environment to be rather confusing. On the positive side, the volatility we’ve been experiencing can make for a dynamic trading environment, as day traders need volatility to make short-term profits. On the downside, however, volatility also poses tremendous risks, particularly if you don’t understand its response to economic events.
We’re in a period of high inflation and a potential deepening recession. Economic news that’s considered “good” in a normal economic environment may receive a negative market response, and vice versa. Here’s a quick summary of some of the major concepts that can give you a better understanding of the market environment you’re attempting to trade.
1 – The FOMC Rate Decisions
The “soft landing” that Wall Street was hoping the Federal Reserve (the Fed) would pull off is more or less out the window, according to Fed Chair Jay Powell.
Traders are starting to get a sense that the Fed will need to crash the economy in order to rein on inflation. Still, the market will rally if any of the Fed officials hint at the possibility that the Fed can slow the pace of rate hikes.
But economists have different expectations as to how high interest rates might have to go in order for inflation to subside. St. Louis Fed President James Bullard believes interest rates will have to go as high as 5% and 7%.
The FOMC rate decisions will likely move the markets, but not as much as the guidance post-announcement, the Fed minutes, and any of the Fed speeches or interviews that take place at different times throughout the month. So, watch your economic calendar for these scheduled announcements!
2 – CPI, PPI, and PCE
The CPI reflects last month’s consumer inflation rate. The PPI reflects last month’s manufacturing inflation rate. The PPI is somewhat a leading indicator because higher manufacturing costs may lead to higher consumer costs should businesses decide to raise prices to make up for their loss in revenue due to higher prices. The PCE is the Fed’s favorite inflation indicator as it’s more closely aligned to GDP categories.
When any of these reports are released, interpret them in relation to the previous months. Any easing in the CPI or PPI can give investors an impression that inflation is peaking. But the figures can rise again in the following months. This happened throughout the 1970s, so be wary of this pattern. For instance, from 1970 to 1972, CPI inflation went from 5.8% to 3.3%, a sign of easing. But in 1973 and 1974 it jumped to 6.2% and 11.1%. No peaking, just a “drunken walk” upward.
3 – Jobs Data
You might have noticed how declining weekly jobless claims, reported every Thursday, caused the stock market to decline. How is it that fewer people out of jobs prompted a negative response? It’s because the Fed is trying to “slow” the economy. Strong employment is a sign of a growing economy, and it’s the very thing the Fed is trying to slow down.
Fed Chair Jay Powell, back in September, already telegraphed that it may expect unemployment to tick up, not down. So, any indication that the labor market is strengthening— whether it’s the weekly jobless claims report, or the monthly Employment Situation (aka Jobs Report) JOLTS (job openings), or the ADP National Employment Report—may elicit a negative response in the markets, Remember, the Fed is trying to slow the economy. In this scenario, signs of growth are signs that the Fed’s tightening policies haven’t yet kicked in.
4 – Consumer Confidence and Sentiment
These reports are generally based on surveys. They aim to forecast one thing: are consumers and businesses going to spend or invest, or are they in “savings” mode? If there’s any indication that “demand” is high, and that more spending is to be expected, then that means inflation (on the demand-pull side) is likely to rise. Remember, spending can increase inflation, as demand amid low supply often causes prices to rise.
This is where you’d compare the confidence surveys with any of the industrial or manufacturing index reports that are also published on a monthly basis. If demand is high while manufacturing production begins to slow, then you’re looking at a high demand/low supply scenario.
But if both demand and production slows, then you’re looking at a potential recessionary situation.
5 – Monetary Policy’s Lag Time
In the news, you’ll often see people ask, “why aren’t the rate hikes doing anything?” What many people don’t realize is that it can take up to a year for the Fed’s policy efforts to work its way into the economy. This means that last month’s rate hikes might not fully take effect until the Summer or Fall of 2023. This is something for you to think about when trying to forecast the environment, or a market top or bottom.
The Bottom Line
The economy is not a washing machine. It doesn’t “cycle” in a way that’s accurate and predictable. Reading the economy in order to trade market opportunities is more art than science. Although long-term fundamentals might not help you trade short-term opportunities, it helps to understand the big picture in order to find the best “waves” while trying to avoid getting financially injured or wiped out. Good luck!
Please be aware that the content of this blog is based upon the opinions and research of GFF Brokers and its staff and should not be treated as trade recommendations. There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results.