The Federal Reserve has been raising interest rates for over a year. The markets have taken a big hit. As inflation comes down a bit we hear the occasional wishful thinking that the Fed will achieve a “soft landing.” In other words they will cure inflation without causing a recession, driving businesses into bankruptcy, and causing years of higher unemployment. Everyone watches the consumer price index and similar indicators. Other factors are not commonly followed but give us a hint about how bad it really is and how much worse it could get. How bad will the recession be and how can we trade it profitably?
Americans Behind on Car Payments Worse Than 2009
When inflation surges folks who essentially live paycheck to paycheck have to start making decisions about what to buy and what to forego. As noted in Bloomberg, one of things folks are letting slide is the monthly car payment. The Bloomberg article follows one person who had their car repossessed which caused them to lose their job delivering for Amazon which caused them to fall behind on rent payments and be unable to buy enough food even with food stamps. This is the story that lies behind CPI numbers and it is multiplied by millions.
Fighting Inflation Leads to Recessions
We said that the Fed should have acted soon but they dragged their feet and let inflation get worse. Then they started raising rates and have succeeded, to a degree, in bringing inflation down. The market has repeatedly engaged in wishful thinking about the Fed cutting back on how fast they raise rates despite Chair Powell and company repeatedly saying that there will be economic pain before they are done. The last time inflation was as high as it got in 2022 was at the end of the 1970s and under Paul Volcker the Fed raised rates astronomically. It caused a recession and employment did not recover to prior levels for 7 years.
How Does This Affect Options Trading?
At Top Gun Options we pay attention to things that drive the economy or will potentially drive stocks up or down. Our DRINC acronym has to do with Democrats, Russia, Iran, North Korea, and China. We also pay attention to employment numbers, cost of living indexes, and the like. The point is that data that has to do with the economy affects the markets as well. Because the market always seeks to anticipate events, it often goes down before the economy and starts going up before an economic recovery. Knowing this allows us to plan our options trading strategies for better profit potential.
Buying the Fed Rumor and Selling the Fed News
As the Fed tries to deal with inflation, they meet to discuss interest rates and then announce their plans. Speculation prior to meetings of the Fed’s Open Market Committee can take the market up or down. We commonly trade one way as the market rises or falls “on the rumor” and get out or enter a new trade before an announcement is made which is the news that we are then selling. It is important to have a sense of how bad the recession will be. That is because the market tends to love wishful thinking and follows short term hype. Then it reverses and wipes out previous gains. At Top Gun Options we preach to always hedge trading strategies. Time and time again, such as with the early days of the Covid Crash, wishful thinking caused traders again and again to buy into short term upticks only to get wiped out as the market fell again and again. This will likely be the case with the coming recession where it will not be a good idea to be trading alone but rather trading with one of the squadrons at Top Gun Options where we potentially print money no matter which way the market is going.