The Federal Funds Rate and Trading Activity

On Wednesday, 14 December 2016, the Fed FOMC (Federal Open Market Committee) will be meeting to announce a decision on the federal funds rate. The FFR was raised by 25-basis points in December 2015 to the 0.25% – 0.50% level. Several rate hikes were promised in 2016, but with just 1 meeting of the Fed remaining, it’s do or die on Wednesday, December 14. For the most part, there is near unanimous agreement that the Fed will raise rates by 25-basis points. This will place the federal funds rate in the 0.50% – 0.75% range. It should be borne in mind that markets have already priced in a rate hike. The announcement on Wednesday is a mere technicality at this point. If we look at the current probability percentage of the rate hike, it is hovering around the 95% level, and has been for quite some time.

Strong Bias Towards Call Options on the USD

The world’s premier online trading enterprises such as TradePlus have reported significant enthusiasm from traders with the upcoming rate hike. For starters, all major currency pairs featuring the USD have seen net long options being placed. Top pairs like the USD/CAD, USD/JPY and GBP/USD have all moved in favor of the greenback. Indeed, this is bolstered by a resurgent DXY (US dollar index) which measures the performance of the greenback against 6 global currencies. These include the JPY, EUR, CAD, GBP, CHF, and the SEK. The most heavily weighted currencies in the mix are the EUR, JPY, GBP and CAD. Volatility drives currency markets, and while the Fed rate hike is a virtual certainty there is still significant upside momentum. This is due to the Trump phenomenon.

Wall Street Bulls Are Charging

President-elect Trump has promised to drain the swamp and inject massive fiscal stimulus into the US economy. We have already seen incredible momentum on Wall Street with the Dow Jones Industrial Average rallying to record levels. At over 19,000, many traders and investors are scratching their heads, wondering how much higher equities markets can rally. Likewise, the S&P 500 index and the NASDAQ composite index are also testing new highs. The significance of a rate hike cannot be discounted. For starters, higher interest rates from the Fed filter through to Wall Street and Main Street almost immediately. Since banks charge higher rates of interest on money that they lend out, banks will be profiting from the Fed. We can expect all the big US banks such as Bank of America, Citibank, JP Morgan, Wells Fargo & Company, Goldman Sachs, and others to see a sharp spike in their share prices in 2017. Binary options traders are not missing a trick either. Call options on banking and financial stocks are a safe bet in the present economy.

What about Commodities?

There is a strong correlation between interest rates and commodities like gold, silver, and crude oil. For starters, all dollar-denominated commodities will be affected by a stronger USD. Gold typically reacts negatively to a stronger greenback which is brought about by rising interest rates. However, studies have shown that gold demand will not necessarily decline if interest rates rise. We do know however that equities markets tend to fare poorly with higher interest rates. The reason for this is that many of these listed companies have loans with banks and higher interest rates mean that their debt obligations will increase. Unless these companies pass on these costs to consumers, their profitability will decline.

As a result, share prices decline. We are seeing the makings of a downturn in equities markets, but the Trump phenomenon is likely to act as a buffer to prevent such movements. Crude oil is less likely to be affected by the rate hike than it is by the introduction of WTI crude oil producers back into the mix. Now that OPEC has agreed to cut production in January by 1.2 million barrels per day, US crude oil producers will likely fill the void. The short and sweet of it is this: go long on the USD with call options, and short on mining stocks which are taking a beating with a weak gold price.