Market Reacts To Fed Rate Hike Announcement

2022-05-04

Market expectations centered around the Federal Reserve announcement Wednesday and a promised interest rate hike of 50 basis points.

The Fed – Federal Reserve – didn’t disappoint and the half-point interest rate is scheduled for May. This is the highest rate increase in two decades.

The stock market chopped sideways Wednesday from the open through the Fed press conference, then it kicked into a short-covering rally. The run sent the three major indexes higher.

The Dow closed at 34,061.06 points to jump 2.81% (adding 932.27 points on the day). The Nasdaq climbed to 12,954.98 points for a 3.11% spike higher while the S&P 500 rounded at the rally with a 2.93% gain to 4,297.84 points.

(Check out the free video, above, for insight into trading this changing market.)

Rising inflation forces Fed rate hike announcement

The Fed painted itself into a corner leading into the mid-week announcement and had to raise interest rates in an attempt to curb escalating inflation.

The impending rate hike has made trading difficult in recent sessions – not knowing the full rate hike or how the market and individual stock prices would react.

The market is also watching what happens with inflation pressure on the overall economy, consumers, and individual stocks.

Inflation hit 8.5% at the end of March compared to 2.6% at the same time last year. This is a four-decade high not seen since 8.9% in December, 1981.

Inflation data for April should be released next week, and expectations are inflation fears will continue to influence consumers and the market.

Market shift hits shorts, weakened tech

So far overall market reaction to the Fed announcement has held true to form – the news sent the market scrambling.

Shorts took it on the chin during the ensuing late-day rally. A short covering rally is a situation where traders hold short positions and when the market moves higher they must balance their positions by buying into the rally. With a large number of short positions, all the buying to cover the shorts creates a rally.

The rise in prices typically does not last long as it slows once all the short positions are covered.

Simpler’s traders who anticipated a dramatic move for the day watched for bearish setups to the downside early in the session Wednesday. (They planned to be “in and out” before any fast action caused by the Fed announcement.)

Technology stocks are still weak in this market, despite the afternoon rally, and Simpler’s traders watched ROKU, FB, and NVDA for early-day downside setups. This may indicate tech weakening further if price and chart structure holds.

As covered in the This Week In The Market report Sunday, keep in mind that the real move in the market may be the day after the Fed announcement.

Simpler’s traders are staying nimble to see how the market reacts into Thursday.

This is a tricky market for any trader, but there are opportunities for those able to handle the heat.

Don’t underestimate Fed influence on markets

This Fed announcement is not something traders should passively ignore.

Even Simpler’s traders, who lean primarily into technical analysis, understand that the Fed exerts influence over the economy and thus the markets. And with this much hype prior to this announcement, the Fed message was loud and the market was all ears.

Traders who followed the Fed report are ahead of the game while those just realizing its impact should adjust to the news.

This is the type of announcement that can catch traders off guard – at any experience level – and send short-term trades into the loss column. Savvy traders will stay informed about Fed news and work setups that hold potential for profit.

How should you trade around a Fed announcement?

Be aware of how this type of market-influencing news may impact your trading even after the Fed news day. Keep in mind the following:

  • Never risk in any trade amount more than you are willing to lose. A trader playing lotto setups prior to a Fed announcement must be prepared to never see that capital again. Intraday action around Fed reports can be furious and unpredictable (like today). A trade in this time frame should be considered higher risk like a setup that holds through an earnings report. In either case, no matter how positive or negative the news, the market may react in a direction against what you anticipated.

Any trade surrounding a Fed announcement is 100% at risk.

  • The slightest change in expectations prior to the announcement can spur markets to react drastically. What if the market “baked in” a .5% interest rate hike and the Fed went ahead with an even more aggressive 1% hike? Be informed of how the Fed affects market action.
  • The overall market tends to chop in a defined range heading into Fed news. Yet, last Friday the market sold off heavily – all three major indexes closed lower to finish out an historically down month. The market opened down this week, then surged back to positive by the close on Monday, and then chop continued into the Fed report.
  • To navigate this volatility, traders can consider watching the market in the first 30 minutes to one hour of the trading day.

Watching the market early in the session can help reveal more defined highs and lows of what the daily range might settle into.

  • If market chop reveals a wide enough range, there may be setups for intraday trades far enough out from the Fed report. Still, be ready to cover any risk or close trades quickly as needed to avoid being caught off guard once the news is released.
  • Don’t dismiss theta decay. Trading same day or week options expirations around Fed announcements requires knowing how theta decay works within these setups. The volatility of the market often causes options to maintain value longer and not experience expected theta decay leading into the announcement.

After a Fed announcement, traders should expect options trades maintaining higher premiums (or out of the money strikes) to fall off quickly in price.

  • Playing a trade setup through a Fed announcement is risky because any move against a position for short-term and same-day trades can quickly send the trade value to zero.
  • Expect the expected. This means, to a high level of certainty, there will be a dramatic directional move in the market following a Fed announcement. As stated above, the market may react bullish or bearish against expectations.

The market is coiled to react after each announcement.

  • Like a snake, the market may slip one way and strike back in the opposite direction at lightning speed with no warning. As seen on Monday of this week, the market may sell off most of the day and then digest the news further to only rally higher within a few minutes. The same can happen in reverse, and all of this may happen the day after a Fed event. Any setups in this situation should be monitored closely.
Be aware of risk during Fed events

Always be aware of risk against capital and the cautions above. There is plenty of media hype surrounding Fed announcements, but ultimately it is “just another day” in the ongoing trading world.

Traders who are nervous about trading before, during, or even after a Fed announcement can always “stay in cash.”

Sitting out the volatility is a legitimate and risk-averse trading strategy.

For those who want to “test the waters” and stay in tune with how the market works around Fed news, push options setups further out. This offers the opportunity to trade through the announcement and get beyond any dramatic market reaction.

Day trade during volatility

Learning the “do’s and don'ts” of day trading before the next Fed event or earnings season is something to consider for any level of trader. Knowing how to get “in and out” with targeted timing to maximize profit potential is a necessary skill for learning how to day trade.

Why face any market volatility by yourself when you can trade with a team?