All traders, both retail and institutional, have overreacted to a rogue headline or a baseless tweet at least once in their careers.

In this new world where information and news, much of which is completely unverified, is thrown at us from every angle possible, it’s often hard not to overreact by exiting a position prematurely or entering a position at a poor price point.

This is why it’s so important to always know where the stock you’re trading stands on multiple timeframes, and not just uber short-term intra-day charts.

Today I’m going to break down how the Fed impacts the markets, and how you can prepare yourself for their next move.

The Fed is now looking for higher inflation over the years ahead

This past week, the Federal Open Market Committee (FOMC) held one of the eight meetings it holds each year.

The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve System (FRS) that determines the direction of monetary policy by directing open market operations, which is the practice of buying and selling primarily U.S. Treasury securities on the open market in order to regulate the supply of money that is on reserve in U.S. banks.

Essentially, the FOMC’s main purpose is to set monetary policy in order to fulfill the mandates of the Federal Reserve, which include price stability, maximum employment, and stable long-term interest rates.

This past week’s meeting was particularly important because it was the one meeting that is held each quarter which includes a Summary of Economic Projections.

Although the FOMC made no substantive policy changes at Wednesday’s meeting, the Summary of Economic Projections revealed a change in the FOMC’s outlook on inflation.

Specifically, for the past several months the FOMC’s stance has been that increased inflation resulting from epic levels of monetary stimulus making its way through the economy is only transitory.

However, from this meeting we have learned that the median FOMC policy maker now expects two interest rate hikes by the end of 2023, up from zero in the last meeting.

Perhaps even more significantly, 7 of the 18 committee members expect that rates will be higher at the end of next year, and 13 members look for higher rates at the end of 2023.

In other words, the Fed believes the US economy will more quickly approach its dual mandate of inflation averaging 2% and maximum sustainable employment, which leads to this key point, which is that market participants now respect the possibility that the Fed may move to normalize policy more quickly than before.

The Fed is notoriously wrong, so pay closer attention to markets

If you’re new to trading, it’s important to understand that the Federal Reserve is notorious for being poor at timing changes in its policy direction.

As it pertains to the latest FOMC meeting, there’s no denying that the change in the Fed’s inflation outlook is important.

Why is it important?

Because it goes against the narrative it had been pushing for several months heading into the meeting, which is that it believed recent inflationary pressures would prove to be “transitory,” and that no meaningful change in policy would be needed to halt the spread in inflation.

While the change in the Fed’s inflation outlook seems to have spooked the market during the 2nd half of this week, since any action taken by the Fed to slow inflation would mean the removal of stimulative measures that help support risk assets like stocks, it is important to understand that important changes in the Fed’s language rarely mark THE turning point in markets.

Instead, it typically begins a process where both institutional and retail investors look for signs that either confirm or negate the Fed’s new language.

Common signs typically come in the form of economic data, along with movement in key economically sensitive markets like interest rates and commodities.

When it comes to economic data, investors will be looking to see if the numbers, for the most part, come in “hot” over the coming weeks-to-months, as this would support the inflationary outlook.

When it comes to price movement in markets, investors will be looking for any indications that the strong uptrends in interest rates, industrial (base) metals, and agricultural products seen over the past 12 – 14 months have resumed.  

As the chart below reveals, these key markets are all in corrective mode right now.

Lastly, when it comes to stocks, this is where pattern analysis really comes into play.

Specifically, because a process of confirmation must now take place to determine if the Fed will indeed move closer to taking action to thwart inflation somewhere in 2022 or 2023, the market’s opinion of this information will start to reveal itself in some sort of pattern in the S&P 500.

For investors that may be growing anxious about the prospect for increased volatility as a result of this past week’s monetary events, remember these two items:

• with volatility comes opportunity
• topping is a process

Right now, with the S&P 500 trading less than 2.0% below its all-time highs (still shy of the very common 3% to 5% correction seen over any decades) and within its rising post-November ‘20 channel, the chart below reveals that there are NO indications that a major topping process has even begun.

The train keeps rolling…make sure to stay on track.