Trading Note #8: Betting on FOMC Decisions

Well, I made a costly mistake this week: I betted that the Fed would not cut rates on 18 Sep 07.

Apparantly, the futures market had a 100% expectation of a 25 basis point cut, and many news articles were clamoring for a 50 basis point cut. The reason that the market gave was that with the credit/liquidity turmoil currently, a recession could potentially develop, hence the Fed should cut rates. However, I felt that the Fed would not bow down to the market pressures and would instead only cut rates when there are definite signs of a slowdown/recession. In fact, with the oil prices making new highs this week and other indicators showing signs of inflation, I felt that that inflation is still a potential problem, so it would be unthinkable to cut rates.

As it turns out: I was wrong. Bernanke bowed down to market pressures and cut rates by 50 basis points.

As a bet against a rate cut, I had liquidated most of my positions, and ended up missing a 15% rally on my positions over two days. With my stocks now at a short-term high, I’m very cautious of going back in for fear that the price level would drop significantly back to pre-rally levels, even though the stock is still clearly undervalued. It made me realised how much a good thing it was to buy a large position when the stock was trading ridiculously low. The psychological comfort and safety of buying in at an extremely low price was wonderful. I should not have let go of that and should have held my position.

On hindsight too, I realised that I was making a call based on a wild guess. I had no idea of Bernanke’s personality, no idea of what kind of pressures/influences the FOMC was subjected to, and no idea of many other factors that would impact the Fed’s decision. I was literally speculating, in the purest sense of the word. Hence my lesson: Never speculate on Fed decisions ever again.

Interestingly, I saw this article about an interview with Warren Buffett on the Fed rate cut (link here). The important quote from Buffett:

The important thing in stocks is to buy a stock in a good business at a reasonable price. Anybody that is buying or selling stocks based on what the Fed is doing, or what they think they’re going to do at their next meeting, I think is destined to not having a great financial future. It really doesn’t have anything to do with the value of good companies 3, 5 years from now. People who think they can dance in and out based on Fed signals, I think, they’re going to make their brokers rich, but they’re not going to make themselves rich.



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