Preparing for the 'Biggest Fed Decision Ever'

How is the market pricing the upcoming Fed decision?

Sep 16, 2015 at 10:11 AM
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It's finally here! Fed Day. Not just any Fed day, but: The. Biggest. Fed. Decision. Ever. Sponsored by DraftKings. "Real People, Real Money, Real Interest Rates." Also sponsored by FanDuel: "It's Absolutely, Positively Not Sports Betting ... Really."

We've wildly anticipated this day for at least a year, ever since we stopped obsessing over whether the Fed would taper its bond purchases. And now, we find out once and for all whether they will raise rates 25 basis points! It's beyond exciting. I mean, think of getting like 0.25% on those bank deposits instead of 0.13%, or whatever it is right now.

Okay, I realize that's not the point. It's trillions of dollars to the banks! Or not, really. Bonds and lending rates and all have perpetual markets and … Why are we obsessing over this again? Well, whatever, not my decision what goes viral.

The market seems to expect the Fed not to do anything, though there are variables on what they actually say. They might signal a rate cut next time, say whether it's one and done or not, etc. Our job isn't to predict what they do, but rather to predict the reaction.

The market itself is acting well heading into the Fed, within the context of a generally weak stretch. We're at the higher end of the post-melt range, with a bit of a gap above and a bit more room beyond that to the earlier 2015 SPDR S&P 500 ETF Trust (SPY) lows, in the 205 range. On the downside ... everyone and their guru seem to anticipate a retest of the August lows in the mid-180s. Hard to imagine we see either today.

We can analyze SPY options heading into this the same way we analyze single-stock options ahead of an earnings report. The volatility pop in nearer months suggests a certain reaction is priced into the options. As I type, SPY is "predicting" about a 3-point reaction, or roughly 1.5%. That's somewhat high for a Fed meeting, but again, this particular announcement is so anticipated, and volatility in general is elevated. With the CBOE Volatility Index (VIX) at 22.50, we'd expect two-thirds of days to see ranges a shade under 1.5% anyway.

The best news is that we're finally done yapping about the meeting. Unless, of course, they do nothing, and we start talking endlessly about the next meeting. Because, clearly, that will then become the Biggest. Fed. Meeting. Ever.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

 

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