Fellow Traders, |
Tomorrow, the Federal Reserve will hold its sixth meeting of the year... |
And a lot of media outlets will treat this event with the same flair as the Super Bowl meets the All-Star Game. |
Before you get swept into the headlines and all the jargon, I wanted to take a moment to walk you through what the Fed actually does… and why, if you stay informed ahead of this event, you can profit handsomely as a trader. |
This is far less complex than these pundits make it… |
What the Federal Reserve Actually Does |
If you don't know me, I'm Garrett Baldwin. I was once a person who had no understanding of what the Fed does. |
Until I spent the better part of my early 30s studying it in Washington, D.C., at Johns Hopkins. From there, I spent the next decade digging deep into the relationship between the Fed and the stock market. |
What I'm going to tell you today is the straight-down-the-middle insight into what the Fed is and does. |
But then I'll pull back the curtain to show you how their decisions impact your money and tend to lead to higher markets with temporary… spectacular crashes… |
The simple fact is that the Federal Reserve is the central bank of the United States. |
Created in 1913, the Fed acts as a source of financial stability and monetary support for the broader economy. It was created a few years after the Panic of 1907, a massive banking and commodity crisis that forced banks like JPMorgan to provide bailouts to the public. |
In essence, the Fed became the lender of last resort to the financial system. |
Over time, the Fed evolved into a more active manager of the country's economic conditions. |
They have several jobs. |
The first is to engage in what's called "monetary policy." |
This is a fancy way of saying they set interest rates and manage the U.S. money supply. |
Their goal is two-fold: to ensure that we have a robust labor force (people have jobs) and to help stabilize prices with an annualized inflation target of 2%. |
Now, I'm not going to comment yet on whether they're any good at their job… But it's important to note that the vast majority of market participants believe and expect the Fed to be independent and target those outcomes. |
Meanwhile, the Fed supervises and regulates banks to ensure the safety of the financial system. They provide financial services to the government and financial institutions through the form of lending. |
And they have one very important, non-official mandate. |
Given that the U.S. dollar is the global reserve currency, it must maintain stability in times of crisis. This can include processes such as Quantitative Easing, where central banks purchase bonds from the market and inject money into the financial system. When they need to reduce inflation, they will let these bonds expire or sell them back into the market in a process known as Quantitative Tightening. |
But there's one last thing you need to know. |
And that's what makes Wednesday so important. |
Why FOMC Meetings Matter for Traders |
The Federal Open Market Committee (FOMC) is in charge of the federal funds rate (the rate banks charge each other for overnight loans), reserve requirements for banks, and open market operations (buying and selling government securities to influence money supply). |
They will decide tomorrow whether to raise, cut, or keep interest rates at the current level. |
Tomorrow, markets expect the Fed to cut by 25 basis points (or a 0.25% reduction). Doing so will result in significant price changes across every asset class. When the Fed adjusts the federal funds rate, it affects everything from mortgage rates to corporate borrowing costs to currency values. |
Then, at 2:30, Fed Chair Jerome Powell will speak. His outlook (known as forward guidance) will help shape market expectations months in advance. |
Markets often move more on FOMC days than on any other scheduled event because algorithms and traders parse every word for clues about future policy direction. In addition, every major institution in the world has taken a position and hedged against any surprise from Powell. |
The Key Data Points |
Tomorrow, you're going to listen for some key words. |
First, you'll hear a lot about inflation and metrics like CPI and PCE. These are the inflationary metrics the Fed analyzes to determine whether prices are rising or falling too rapidly. Then they will examine the official monthly job reports, unemployment rate, and wage growth. They'll analyze GDP growth and economic activity indicators, as well as financial conditions, including credit spreads and bank reserves. |
Understanding what the Fed watches helps you anticipate its moves. |
Hot inflation pushes them toward tightening. |
Weak employment pushes them toward easing. |
Financial stress forces their hand regardless of other data. |
Now, Let's Talk About What's Really Happening |
Now… here's where the textbook explanation meets trading reality. |
The Fed's biggest unspoken mandate is managing the federal government's $35 trillion debt load and ensuring that there isn't a massive financial crisis in the future. |
When interest payments threaten to overwhelm the federal budget, they ease. |
When inflation becomes politically dangerous, they tighten just enough to look responsible. |
This isn't a conspiracy theory; it's math. |
At 5% interest rates, annual debt service would exceed $1.75 trillion, surpassing Social Security and approaching the entire discretionary budget. |
The Fed cannot let rates normalize to historical levels without triggering a fiscal crisis. |
They know this. Wall Street knows this. Now you know this. |
Since 2008, every Federal Reserve cycle has followed the same pattern. |
They ease until inflation forces them to stop. They tighten until something breaks. |
Then they panic and ease even more aggressively. Each cycle requires more intervention than the last because the debt grows faster than the economy. |
The 2019 repo crisis happened when bank reserves dropped too low. |
The Fed immediately pivoted from a tightening stance to one of easing. |
The 2020 pandemic gave them cover for unprecedented money printing. |
The 2023 banking crisis forced them to pause hiking despite hot inflation. |
The pattern never changes…print, inflate, pause, something breaks, print more. |
Trading the Fed's Reality |
You're not trading individual companies as much as you're trading liquidity conditions. |
When the Fed expands liquidity, asset prices rise broadly. |
When they contract it, correlations go to one, and everything falls together. |
The Fed telegraphs its reaction function. They tell you what would make them pivot. Your job is to identify what's about to break and position for their predictable response. |
Currently, bank reserves are approaching $3 trillion, a level at which repo markets have historically seized. |
Commercial real estate is rolling over. Regional banks are struggling with underwater bonds. |
Something will break. It always does. And when it does, the Fed will pivot from fighting inflation to providing liquidity. |
That's just how the system works. However, that's not something everyone needs to know. |
Just us… and we'll talk about more of that tomorrow at 2 pm. |
The Trading Edge |
The Fed isn't trying to help your trades. |
They're trying to keep a highly leveraged system from imploding while maintaining the illusion of control. |
But that makes them predictable. |
They'll always choose inflation over deflation. |
They'll always rescue the banking system. |
They'll always pivot when markets crash enough to threaten pensions and 401 (k) s. |
Understanding this doesn't make you cynical. |
It makes you profitable. |
Trade the Fed's reality, not their rhetoric. |
We'll see you tomorrow. |
Join me at 8:45 ET for a preview… |
Garrett Baldwin |
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