DON’T FIGHT THE FED “Don’t fight the Fed” is a rule of thumb that, based on historical averages, investors may gain an advantage by investing in a way that aligns with the current monetary policies of the Federal Reserve, rather than trading against them.

However, there are times when the “Don’t fight the Fed” rule of thumb must be ignored and fighting the Fed is the exact right thing to do. The bulls correctly ignored this rule when the Federal Reserve was hiking its fed funds rate all through the December 2015 to the December 2018 period. During this span the Federal Open Market Committee increased its fed funds rate from a target range of zero to 25 basis points to 2.25%-2.50%. Traditional thinking this is when the Federal Reserve is increasing interest rates, stock index futures should normally decline in price. So why did this rule of thumb fail so miserably, as stock index futures advanced to a series of record highs?

One very important factor to keep in mind is that while the Federal Reserve was steadily hiking interest rates, by historical standards interest rates were still extremely low, and in spite of the nine rate hikes from the Fed, the fed funds rate was still very accommodative. Remember that the fed funds rate was as high as 20% in 1980 and averaged close to 10% in the 1980s. European central banks in the late 1970s and early 1980s had correspondingly high interest rates, as well.

Now, in a reversal of the Federal Reserve’s hawkish monetary policy, the Fed has embarked on a new path of easier credit conditions, starting with the July 31, 2019 quarter point cut in its fed funds rate to 2.00%-2.25%, followed by a second rate reduction of 25 basis points to 1.75%-2.00% at its September 18, 2019 meeting.

In addition, the Federal Reserve recently said that it would begin buying approximately $60 billion per month in Treasury bills to ensure “ample reserves” are in the banking system. This program will continue at least until the second quarter of 2020. While the Federal Reserve said the program is “technical” and is in response to recent disruptions in short- term money markets and is not a change in the “stance” of monetary policy, many market participants believe it should be considered an additional form of accommodation. The still historically low global interest rate environment and now the Federal Reserve expanding its balance sheet remains a major tailwind for the bull market in U.S. stock index futures.

Chart 1: S&P 500 Futures - Monthly

Source: Chart from QST

14 | ADMISI - The Ghost In The Machine | November/December 2019

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