Life hack: how to find out the rate of the Fed and the Bank of England before they are shown in the news feed
Once a month and a half, our minds are excited by events such as meetings of the US Federal Reserve, the Bank of England, the European Central Bank and many other banks whose currencies are included in our investment portfolios. In this short article I want to talk about a small secret: how to almost certainly find out what the meeting of the Fed and the Bank of England will end with - increase, lower or leave the interest rate unchanged. I must say right away that the life hack described below only works for these two banks. You will soon understand why.
What is the discount rate: just about complicated
What is the discount rate? This is the interest rate at which the Central Bank funds commercial banks. In theory, and in practice, too, usually too, lowering the rate stimulates lending, and raising it, on the contrary, slows it down. Intensive lending increases economic activity, which can lead to higher inflation and accelerated depreciation of money. Therefore, the Central Bank's policy is as follows: the decline is replaced by an increase, which is replaced by a decrease. In general, a conventional system with regulatory feedback. The drain tank is also arranged in the restroom. Below I will show how it works.
Each time you press the toilet button, the inlet valve opens inside. Water leaves faster than a new one arrives, so the valve opens more and more, until all the water leaves. When interest rates are high, there is no influx of fresh money, the economy stagnates because it is difficult to expand production and stimulate demand. But only in the Central Bank they lower the toilet button, I wanted to say they lower the rates, so immediately the influx of new cheap money begins.
When all the water the old water is gone, the new one arrives with great force, because valve is fully open. At this time, we observe financial bubbles in the economy, lending to everyone and everything, more than enough money. In general, rates are low - economic activity is growing, and with it inflation.
Water in the tank rises gradually, which means that rates in the economy begin to rise, i.e. the valve is covered. The economy is slowing, the flow of water too.
Water rose, the valve closed: the rate is at maximum, the economy needs cheap money; enterprises choke without loans. It’s time to lower the bid, i.e. drain the water again. And so every time.
I hope this simple comparison helped to understand how the counter-cyclical policies of the Central Banks are structured. Of course, everything is a little more complicated (for example, the flow of water during the discharge process increases for some time, and the Central Bank, in turn, reduces the rate for some time, i.e. this is a pro-cyclical policy), but we do not need to know more.
I hope I have explained quite popularly how the Central Bank regulates economic activity through the rate.
The role of the Chicago Stock Exchange in the change in US Federal Reserve rates: how everything really works
The policies of the Central Banks are monitored not only by forex traders with a hundred bucks in the account, but also by so serious uncles and aunts that they are not even shown on television, but they manage funds with a capital of tens of billions of dollars. The first hope after the news ride for fifty points, and maybe even 150 for half an hour. For the latter, the return on investment depends on the interest rate, where a change in the funding rate of 0.5% can turn an extremely profitable business into a loss-making business (long and hard to explain, take a word).
Central banks try to take into account the interests of serious uncles and aunts, but they do it very beautifully. In order to tell in more detail about this symbiosis of large business and the state, you need to understand the role of the largest exchange platform in the world - CME Group. The CME Group includes such exchanges as CME (Chicago Mercantile Exchange), CBOT (Chicago Board of Trade), NYMEX (New York Mercantile Exchange) and COMEX (New York Mercantile Exchange): the largest American, and therefore global commodity futures exchanges.
Thus, her specialization is the derivatives market. Derivatives market is a futures and futures options market. Futures are currency, commodity, index and others.
If you go to the Interest Rates tab from the main page of the CME Group website, then on the right you can find two links in the Interest Rate Tool section: CME FedWatch and CME BoEWatch. This is what interests us. This is an open secret, which is now also known to Tradelikeapro readers. By clicking on these links you will be taken to pages where, online (this is not necessary), you can watch how investor sentiment changes at the rate for the next and distant meetings.
A full description of the calculation methodology of FEDWatch and BoEWatch can be found on the CME website. But everything is in English, and the built-in translator does not translate correctly. You can don’t follow the link if you don’t need to know how CME Group considers expectations.
The main assumptions are as follows:
The probability of a rate increase is calculated by adding together the probabilities of all target rate levels above the current target rate;
The probabilities of possible Fed target rates are based on Fed futures prices, suggesting that the rate increase is 0.25% (25 basis points) and that the Fed effective rate (FFER) will respond to a similar amount;
The probabilities of FOMC meetings are determined from the relevant futures contracts of the Fed CME Group.
So, both the Fed and the Bank of England take into account what the market expects from them. In the entire history of trading in such futures, and this is more than 50 years old, they have never once gone against the market. But the market is changing its expectations by analyzing the same data as the Fed, i.e. along with Fed officials. Therefore, market expectations are changing. This is another feedback system. The Fed does not change rates until the market shows its readiness for this. The market shows its willingness to change rates when the Fed really needs it. Here you can draw an analogy with a mercury thermometer and antipyretic. With increasing temperature, mercury expands, with cooling it contracts. In the confined space of a thermometer, it looks like raising and lowering a mercury column. If the temperature is high, then the patient begins to drink antipyretic drugs. So it is here.
When the economy worsens (it doesn’t matter how, because a worsening in terms of business activity leads to lower rates, and a worsening in terms of inflation leads to higher rates), the Fed and other institutions send signals (raise the temperature in the media) that the rate should be changed earlier or later. Therefore, investors in the market (exchange mercury) perform certain actions (which can be read on the link to the calculation methodology given above, but this is not necessary), which ultimately lead to a change in expectations of a change in the rate. At some point in time, the market becomes ready for a change (i.e. more than 70-80% of investors are waiting for a change) and then it becomes inevitable (a high temperature of expectations implies taking an antipyretic). If the market is undecided (about 50% is waiting for a change in the rate, about 50% is waiting for the rate to remain), then the Fed will probably not change the policy, but change it. But the comments will hint at what is going to be done in 1.5 months, if the conditions do not change during this time - that is, it will clarify the situation. And this will lead to a change in the ratio of expectations on the rate at the next meeting.
I repeat once again the thought: the Fed just does not change the rate, because this is tied to business with very serious comrades. If we move away from conspiracy thesis towards bureaucracy and economic management (the Fed’s mandate also implies an impact on unemployment, and rates affect unemployment through a decrease / increase in business activity), then we can say that the stability of the financial system implies the maximum reduction in systemic risks, therefore any the actions of the regulator are simply obliged to be predictable, even in an unpredictably changing environment.
FEDWatchtool and BoEWatchtool tools: how to use them
In order to use these tools, you need to have some basic skills.
Ability to read tables and graphs, as well as use the proposed tools;
Understanding the principle of probability distribution of investors' expectations;
The ability to compare tables, graphs, and information changes on them in the long run.
Learning to read the chart.
Here is the print screen of the page and now we will analyze the values of all the buttons we need.
I marked out with red rectangles those areas that are most important to us.
At the top we see a menu with links to expectations for the next 8 meetings. Literally tomorrow (June 19), the next meeting will be held, so we will study at it, as well as on expectations for the July 31 meeting.
On the left we see a menu in which I will describe the following buttons: current, compare, probabilities, historical. By and large, most readers will only need the current button.
In the Meeting information section, we see all the futures information associated with the calculation of rate expectations. In general, this information is neither cold nor hot for us.
But the Probabilities section is very useful. In fact, it succinctly reflects the information presented on the chart. By the word “squeezed” I mean the following. There are only three options in the table: decrease, no change and increase. And on the chart there may be more options, because a decrease is possible by 0.25% or 0.5% points.
Here, for example, are the expectations for the July meeting. Now we see that the probability of a decline is 83.7%. This is a lot. But how really these expectations are distributed, because we read just yesterday or the day before yesterday that GoldmanSachs denies a sharp decrease in rates. On the graph we see that with a probability of 64.7%, a decrease of 0.25% will occur, which is the minimum step. A “sharp” decline, i.e. at once 0.5%, it can happen only with a probability of 19.0%. This probability, by the way, is actually equal to the probability of leaving the rates unchanged on July 31 (16.3%). The same information is presented in the table below the graph, which we will analyze in detail below.
After the Probabilities section, you need to parse the graph. But we have already taken it apart. Each bar is the probability of an event. I think there’s no need to clarify more. I just remind you once again that for a simple understanding of the situation it is necessary to monitor how much the probability of a general change in the rate is higher than the probability of keeping it unchanged. The most interesting situation is when the market expects a change, but the size of the change is not clear. It is in such situations that sharp movements in the market occur.
In general, tomorrow they will not change the rate in any way, and in July they will change it, unless something changes in 1.5 months. But the probability is small.
There is another table below the chart. The first column (target rate) indicates the ranges of bets that are somehow relevant at this meeting. And in the next 4 columns data is shown for bets on the current date, 1 day before the current date; for a week and a month before the current date. Thus, this table allows you to analyze the dynamics of expectations for changes in the Fed rate. The figure on the July meeting clearly shows that over the month, expectations have changed to the exact opposite, i.e. there was an inversion of expectations. Until the July meeting, another 1.5 months, which will be the June meeting, the G20 meeting and a number of other events, the sum of which can change expectations in one direction or another. So you need to monitor expectations at least once every two weeks in order to be in the same information field with real financial sharks.
It's time to move on to the next sections of the left menu. Click on the Compare button and get such a graph at the current rate. What does he show us? In fact, nothing new. This is just a graphically expressed expectations table today, yesterday, week, and month ago. In general, everything is simple and clear. Once again, I recommend evaluating how monthly expectations for the July meeting have radically changed.
The next link on the menu is Probabilities.
This is a fairly informative table with the distribution of the probabilities of bets for the 8 nearest meetings, i.e. a year in advance. Naturally, the probabilities of changes in rates change, but if you correctly understood the Fed’s mandate, on the one hand, and the principle of calculating these probabilities, on the other hand, this table will show you REAL EXPECTATIONS OF A BIG TRANSNATIONAL BUSINESS according to the prospects of the American and world economies. Now the expectations are that at the end of the year the rate will be 0.5%, and maybe even 0.75% lower than the current one. All clear?
The last two links we are interested in are: Historical and Downloads. By clicking on the first link and selecting the meeting of interest (July 31, because it will most likely lower the rate), you can see the change in expectations for the rate for this meeting for the year.
Remember what we had there in the first third of December 2018? Do not remember? In vain, such things must be remembered if you are engaged in trading on the stock exchange. Then the stock market crashed and in general, everything was bad, bad. And it was then that the markets reacted with a sharp change in expectations. And the Fed hasn’t said anything concrete yet, and even hinted at a raise. Remember the thermometer? Well this is it. In general, at this time, investors completely forgot about raising rates, but from the middle of March, they began to think about lowering them.
But just the other day (from the end of May) there is no talk of keeping the rate unchanged. Really interesting?
Let's move on to the last link that interests us - Downloads. This, in essence, is the same as the Historical link, only here you can download this information in a convenient format and analyze it as you need it. Do you need it? I think not really. But monitoring expectations is more than enough.
And what is the Bank of England on the agenda?
The day after the Fed meeting, the Bank of England will meet. I won’t tell anything about him. And you just follow the link to BoEWatchTool, which gave above, or find this link yourself and see the expectations of investors at the rate. When and how are changes in Bank of England policies expected? That's it. Yes, and don't forget to watch the change in expectations after the meeting on Thursday.
- Fedwatchtool and BoEwatchTool are the most reliable source of information on rate changes by the Fed and the Bank of England. Everything that you read in articles (often incorrectly translated), one way or another, relies on the data obtained here. So why trust others with something that you can analyze yourself and know exactly what will happen in terms of rates with a high degree of probability?
- The rate is guaranteed to be changed when this probability is more than 60%. If it is less, then the situation is ambiguous and we should expect the rate to remain. Particular attention should be paid to how much interest can be changed. If there is no consensus (for example, 0.25% or 0.5%), then a real solution can cause strong volatility.
- Studying changes in expectations in the past allows you to find key points in time when the investment community reassesses risks.
- Tracking expectations for rates for the coming year allows us to assess the prospects of the global economy, as well as work together with the investment community (if the rate is lowered after 1.5 months, then the dollar can weaken for one and a half months, and then they will tell us that “the market took into account everything”) .
- On June 19, the rate will not be changed from the word at all, but on July 31, the rate will be reduced by 0.25%. The probability of keeping the rate unchanged and its decrease immediately by 0.5% are equal. The total probability of a rate cut (over 80%) makes this event inevitable in July.