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How much does the S&P have to fall before the Fed contemplates a rate cut

Written by A Forex View From Afar on Sunday, December 21, 2008

When the business cycle changes and heads lower into a trough, usually the equity markets and the Fed Funds start to head lower. The Fed cuts interest rates in order to help the economy, while the equity markets drop as traders’ price in the gloomier earnings perspective.

In the attached chart, we examine the degree the S&P 500 has to fall, in order for the Fed to reduce the targeted Fed Funds rate by 1 basis point. We are going to compare both the S&P downturns in points and percentage, for a better analysis. The S&P crash is not a prerequisite for the Fed to cut, but they usually follow closely.

In the last two decades there have been four notable market downtrends. From each of them, we divided the amount the Fed had cut in basis points to the total points and percentage the S&P lost over the appropriate period.

For example, in the infamous 1987 market crash, the Fed cut 0.40 basis points (0.4%) for every point the S&P lost, while at the same time, the Fed cut 1.42 basis points (1.42%) for every 1% the S&P lost.

It’s interesting to see the similar response the Fed had in the early 90’s, and in current times. In 2001 and 2008, the Fed cut 10 basis points for every 1% the S&P fell. Similarly, the Fed cut roughly 2 basis points for every 1% the S&P lost both in 1987, 1990 and in 1998. Furthermore, it’s amazing to see that almost every crash started in the summer months, except for the Dot-com crash.

However, even back then, in 2001, the S&P was very close in value in the summer months as it was in March, when the high was reached. A short conclusion could be that if something smells funny in the summer months, protect your portfolio with some Calls.

S&P And the Fed

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There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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