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Times in a month and a half our minds excite events such as the meeting of the Federal Reserve, Bank of England, European Central Bank and many other banks whose currencies are included in our investment portfolios. In this short article I want to tell you about a little secret: almost certainly like to know what the outcome of the fed meeting and the Bank of England will raise, lower or leave interest rates unchanged. I must say that the below hack only works for these two banks. Soon you will understand why.
What is a discount rate: just about the complex
What is the discount rate? Is the interest rate at which the Central Bank provides funds to commercial banks. In theory, and in practice usually too, reducing rates stimulates lending, increase – on the contrary, slows down. Increased lending boosts economic activity, which could lead to higher inflation and rapid devaluation of money. Therefore, the policy of the Central Bank as follows: a decrease is replaced by a promotion that gives way to decline. In General, a conventional system with regulatory feedback. So is the cistern in the toilet room. Below I will show you how it works.
Every time you press the button of the toilet, inside the open intake valve. Water goes out faster than it comes new, so the valve opens all the stronger, until such time as all the water gone. When interest rates are high, the influx of fresh money there, the economy is stagnant because it is difficult to expand production and to stimulate demand. But only the Central Bank lowered the button of the toilet, wanted to say lower rates, so immediately began the influx of new cheap money.
When all water is old water is gone, a new one arrives with great force, since the valve is fully open. At this time in the economy observed financial bubbles, lending to all and Sundry, the money is rife. In General, rates are low — growing economic activity, and with it inflation.
the Water in the tank gradually rises, and therefore the economy begins to grow rates, ie valve covers. The economy is slowing, the flow of water too.
the Water rose, the valve is closed: bid high, the economy needs cheap money; businesses without choking loans. The time comes to lower the rate, i.e., strain again. And so each time.
I Hope this simple comparison helped me to understand how counter-cyclical policy of the Central banks. Of course, everything is a bit more complicated (for example, the flow of water during draining for some time increases, and the Central Bank, in turn, for some time reducing the interest rate, i.e. it is Pro-cyclical policy), but we no longer need to know.
I Hope I have sufficiently explained how the Central Bank through rate regulates economic activity.
the Role of the Chicago stock exchange in change of rates of the U.S. Federal reserve: how it works actually
For Central Bank policy is being followed not only Forex traders with a hundred bucks in the account, but so serious uncles and aunts, they don't even show on TV, but they manage the funds with a capital of tens of billions of dollars. The first hope after the news to take a ride on fifty points, maybe even 150 for a half-hour. The second from the interest rate depends on the investment returns, where the change in funds rate of 0.5% can turn a profitable business into a loss-making (long and complicated to explain, believe me).
the Central banks are trying to accommodate the interests of serious uncles and aunts, but they do it very nicely. In order to speak about this symbiosis of big business and the state, it is necessary to understand the role of the largest trading floor in the world – CME Group. Part of CME Group includes such exchanges as the CME (Chicago Mercantile exchange), CBOT (Chicago Board of trade), NYMEX (new York Mercantile exchange) and COMEX (new York commodity exchange): the largest American and thus global commodity futures exchanges.
Thus, it specialize in the futures market. The derivatives market is a market of futures and options on futures. Futures are foreign exchange, commodity, index and others.
If the home page CME Group go to the tab Interest Rates on the right you can find two links in the section Interest Rate Tool: CME FedWatch CME and BoEWatch. This is something that interests us. It is an open secret, which is now known and readers last autumn. Clicking on these links — You will be redirected to page where online (not necessarily) you can see how changing investor sentiment in the bet on and distant the next meeting.
the Full description of the methodology FEDWatch and BoEWatch can be found on the website of CME. But everything is in English, and the built-in translator translates not quite correct. Can't follow the link if you need to know as CME Group believes the expectations.
the Main assumptions are the following:
the Probability of a rate hike is calculated by summing the probabilities of all target levels above the current rate goal rate;
the probabilities of possible target rates of the fed based on the prices of futures contracts, the fed, suggesting that a rate hike is 0.25% (25 basis points) and that of the fed effective rate (FFER) will respond to the same amount;
the Probability of the meetings of the FOMC are determined from the corresponding futures contracts, the fed CME Group.
now, and the fed and the Bank of England consider that they were waiting for the market. In the entire history of the trade in these futures, and it is more than 50 years, has never they did not go against the market. But the market changes its expectations, analyzing the same data as the fed, i.e. simultaneously with the fed officials. Therefore, market expectations are changing. This is another feedback system. The fed did not change the rate until the market shows its willingness to do so. The market shows its willingness to change rates when the fed is really necessary. We can draw an analogy with a mercury thermometer and antipyretic. When the temperature rises the mercury expands when cooled – compressed. In the limited space thermometer, it looks like the rise and fall of mercury. If the temperature is high, the patient begins to drink antipyretic drugs. And here.
When the economy worsens (it's not important, because deterioration in terms of business activity leads to lower rates, and the deterioration in terms of inflation leads to higher interest rates), the fed and other institutions send signals (raise the temperature in the media) that the rate would have to change sooner or later. Therefore, investors in the market (stock mercury) to produce certain actions (which can be read via the link on the calculation methodology described above, but not necessarily) that lead, ultimately, to changes in expectations of rate changes. At some point in time the market becomes ready to change (i.e. more than 70-80% of investors are waiting for changes) and then it becomes inevitable (high temperature expectations implies acceptance of motrin). If the market is undecided (about 50% are waiting for change in rates, about 50% is waiting for the saving rate), then the fed will not change policy rather than change. But in the comments hint that he is going to do in 1.5 months if the conditions during this time will not change — it will bring clarity to the situation. This will lead to the change of the ratio of expectations at the rate at the next meeting.
will Repeat the thought: just because the fed rate does not change, because it is tied to the business from a very serious fellow. If we leave conspiracy theories to the side of the bureaucracy, and the management of the economy (the fed's mandate also includes the impact on unemployment, and interest rates influence the level of unemployment through a decrease/increase of business activity), we can say that the stability of the financial system implies a maximum reduction of system risks, therefore, any actions of the regulator should be predictable, even in an unpredictable changing environment.
Tools FEDWatchtool and BoEWatchtool: how to use them
in order to use these tools, you need to have some basic skills.
the Ability to read tables and graphs, and use the suggested tools;
the principle of the probability distribution of the expectations of investors;
the Ability to compare tables, graphs and alteration of the information on them in the long term.
Learn to read chart
Here is the print screen of the page and now we will examine the values of all of the necessary buttons.
Red boxes I've highlighted the areas that are most important to us.
at the Top we see a menu with links to the expectations of next-of-8 meetings. Tomorrow (19 June) will host the next meeting, so it, as well as on expectations for the meeting on 31 July and will learn.
on the Left we see a menu, in which I describe the following buttons: current, compare, probabilities, historical.
By and large, most readers will need only the buttons current.
the Meeting information tab we see all the information on the futures, which is associated with the calculation of expectations at a rate. In General we this information, neither cold nor hot.
But the Probabilities section is very useful. In fact, he concisely reflects the information provided on the chart. The word “concise” I mean the following. In the table only three options: reduced, unchanged and increased. While the chart may be more options, because the reduction of perhaps 0.25% or 0.5% points.
Here, for example, expectations for the July meeting. Now we see that the probability of decreasing is 83.7%. That's a lot. But actually distributed these expectations, because we read here just yesterday that Goldman denies sharp decline in interest rates. On the chart we see that with probability 64,7%, will be reduced by 0.25%, which is the minimum step. A “sharp” reduction, i.e., from 0,5% can only happen with a probability of 19.0%. This probability is, by the way, is actually equal to the probability of leaving rates unchanged July 31 (16.3 per cent). This information is presented in the table below the graph, which we will examine below.
After the partition Probabilities it is necessary to analyze the schedule. But we have already dismantled. Each column is the probability of an event. I think more clarification is not necessary. Just once again remind you that for a simple understanding of the situation it is necessary to track how the probability of a General change in rates above preserving it unchanged. The most interesting situation is when the market expects a change, but the size changes is not clear. It is in these situations and there are sudden movements in the market.
In General, tomorrow the rate will not change, and in July will change unless something in 1.5 months will not change. But the probability is small.
below the graph there is another table. In the first column (target rate) indicates the range of rates that are somehow relevant for this meeting. And the next 4 columns show data for the actual rates on the date of 1 day prior to the relevant date; for a week and a month before the actual date. Thus, this table allows to analyse the dynamics of expectations for the rate change by the fed. In the figure, devoted to the July meeting, it is clearly seen that for the month of waiting had changed to the opposite, i.e., an inversion of expectations. To the July meeting for another 1.5 months, which will be the June meeting, the G20 meeting and other developments, the amount of which can change expectations in one direction or another. So expectations need to monitor at least once in two weeks in order to is one information field with the real sharks.
it's Time to move on to the next sections of the left menu. Click on the Compare button and we get a graph that at the current rate. What he shows us? In fact, nothing new. It's just expressed in a graphic sign according to expectations today, yesterday, week, and month ago. In General, all is simple and clear. Once again, I recommend to assess how the month has dramatically changed expectations for the July meeting.
the Next link in the menu — Probabilities.
This is quite informative table with the probability distribution of interest rates on 8 nearby meetings, i.e. for the year ahead. Naturally, the probability of changing rates of change, but if you have correctly understood the mandate of the fed, on the one hand, and the principle of the calculation of these probabilities, on the other hand, this table will show you the REAL expectations of LARGE TRANSNATIONAL BUSINESS prospects of the American and world economy. Now, expectations are that at the end of the year the rate will be 0.5% and may be even on 0,75% below the current one. All clear?
the Latter we are interested in two links: Historical and Downloads. Clicking on the first link and select the session (31 July because it is likely the rate will reduce), you can see the change in expectations on rate this session for the year.
will Remember that there was in the first third of December 2018? Do you remember? In vain, such things should be remember if you are trading on the stock exchange. Then there was a collapse of the stock market and in General, everything was bad, bad. And that's when the markets have a sharp change of expectations. And the fed still nothing concrete was said, and even hinted at a promotion. About the thermometer, remember? Well, this is it. In General, in this time of increasing rates, investors have forgotten completely, but since mid-March have started to think about reducing.
But a few days ago (end of may) speeches about keeping rates unchanged no longer in sight. Isn't it interesting?
let's Move on to the last we are interested in link — Downloads. This is essentially the same as the Historical link, only here you can download this information in a convenient format and to perform as you need. And it you need? I guess not. But monitor expectations — more than.
what about the Bank of England on the agenda?
the next day after the fed meeting happens meeting of the Bank of England. I about it did not tell. And you just follow the link to BoEWatchTool, which was given above, or browse to this link and see for yourself the expectations of investors at the rate of. When and how expected changes in the policy of the Bank of England? That's what it is. Oh, and don't forget to check out the changes in expectations after the meeting on Thursday.
the Conclusion Fedwatchtool and BoEwatchTool are the most reliable source of information on change of rate of the Federal reserve and the Bank of England. Everything you read in articles (often incorrectly translated), somehow relies on data obtained here. So why trust the others that it is possible to perform themselves, and know exactly what will happen in terms of bets with high probability? The rate is guaranteed to change when this probability is greater than 60%. If less, then the situation is ambiguous and we should expect the saving rate. Special attention should be given to how much interest can be changed rate. If there is no consensus (e.g., 0.25% or 0.5%), then a real decision can cause high volatility. The study of changes of expectations in the past allows you to find key points in time when there is a reassessment of risks by the investment community. Tracking expectations on the rates for the coming year allows you to assess the prospects of the world economy, and to work together with the investment community (if the rate will lower after 1.5 months, these six months the dollar could weaken, and then we will say that “the market has taken into account all”). On 19 June the rate will not change at all, but on 31 July the rate will reduce by 0.25%. The probability of keeping rates unchanged and its reduction from 0.5% equal. The total probability of a rate cut (over 80%) makes this inevitable event in July.
With respect, Ivan Rusin
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