The month of July 2019 proved to be a pivotal time for monetary policy in the U.S. An escalating U.S.-China trade war threatened to destabilize economic growth and raised questions about the future of international commerce. In a preemptive strike, the U.S. Federal Reserve (FED) reduced the Federal Funds Target Rate by ¼ point ― the first such move since 2008.
So, how does dovish FED policy impact the futures markets? Although the implications can be extensive, there are three primary market-related areas that may be influenced dramatically. Let’s take a look at each aspect and break down how FED quantitative easing affects the futures markets.
#1 Strength in Equities
Quantitative easing (QE) is the expansion of the open market operations conducted by a country’s central bank. Under QE, central banks purchase government securities and reduce prime lending rates to stimulate economic activity. As a result, the money supply is increased, and capital becomes more readily available for consumption as well as industrial growth.
Equities products are one of the largest beneficiaries from QE. Stock values typically rise following periods of relaxed monetary policy because investors take a positive view of forthcoming growth prospects. Over time, this concept has been substantiated, especially as it relates to the S&P 500. Since 1990, the S&P 500 has posted an average 0.57% gain in the month following a ¼ point reduction.
From the standpoint of futures, dovish FED actions can lead to strong short- and intermediate-term rallies in popular equities-based products. It’s not uncommon to see bullish price action in the E-mini S&P 500, E-mini DOW, and E-mini NASDAQ following any sort of dovish FED activity.
#2 Bearish Pressure on the USD
The very nature of QE is closely related to the valuation of money itself. In practice, an increase in the money supply by a central bank works to devalue the domestic currency. From a business standpoint, this can be beneficial because it promotes a competitive edge in the export sector and aggregate economic growth.
However, devaluations negatively impact currency futures. For the USD, values against foreign currencies, such as the Euro, Swiss franc, and Canadian dollar, can fall as a result of dovish FED policy. Products such as the Euro FX (6E), Canadian dollar FX (6C), and USD Index futures (DX) can experience heavy volatility as investors hedge against risks facing the Greenback.
#3 Rallies in Safe-Havens
Given the growth in equities and “risk-on” sentiment typically stimulated by a dovish FED, it’s a bit counterintuitive to also expect strength in safe-haven assets. However, this phenomenon has been historically prevalent during cycles of QE. Values of traditional safe-havens — such as gold, the Swiss franc, and Japanese yen — have a tendency to appreciate in value. Accordingly, gold futures, as well as the Swiss franc FX and Japanese yen FX, have a tendency to gain market share versus the USD.
The most recent example of this scenario was the strong rally from CME December gold futures during the rate cuts of summer 2019. From 1 May to 31 August, gold futures rallied more than $225 per ounce as uncertainty over FED policy boosted investor angst. While there were other important underpinnings driving the bullish action, the accommodative FED tone certainly played a key role in the breakout.
Want to Learn More About the FED?
Without a doubt, actions from the U.S. Federal Reserve are an integral part of the futures markets. A sudden change of official policy, as well as subtle clues, are capable of spiking action across a variety of asset classes. From the E-mini S&P 500 to full-sized gold futures, the impact of a dovish FED can be profound.
A great place to learn more about the FED and stay current on policy is the online educational suite at Daniels Trading. Featuring webinars, blogs, and expert insights, it’s a valuable resource for anyone looking to boost their futures IQ.