forex fire

The Federal Reserve is easily one of the most powerful–and misunderstood–of all American institutions. The Federal Reserve’s steady hand as America’s “central banker” has been especially critical to U.S. economic performance during the past 25 years. Why?

The management of fiscal policy (taxation and spending) during the majority of those years by various Administrations and Congresses was less than admirable. As a result, the enormous and irresponsible buildup of Federal debt remains, for now, our collective lasting legacy.

Today’s Federal Reserve–under the control of Chair Ben Bernanke–enjoys a very high level of credibility as an inflation fighter. In the world of central banks, there is no loftier objective…nor any greater success.

Inflation Control

The Federal Reserve’s number one responsibility is to maintain American price stability. It has been largely successful over the past 15 years in doing so, with consumer prices rising at an average annual rate of 2.7% since 1991. More comprehensive measures of inflation have risen at even lesser rates. In contrast, U.S. consumer prices rose an average of 6.2% annually during the ’70s and ’80s, with a painful bout of double-digit inflation in 1979 and 1980.

Today’s Fed is very concerned that higher energy prices now impacting the economy will contribute to a broad series of price increases for thousands of products and services across the economy. Such a pass-through of energy costs keeps Fed officials awake at night.

Add in volatile commodity and gold prices, the fear of further terrorism in the U.S. and abroad, enormous purchases of U.S. Treasury securities by foreign investors, and a handful of other topics, and one gets a feel for the life of a Fed official. It is not for the faint hearted.

In its efforts to maintain price stability, the Fed many times is called upon to…

1) “take the punch bowl away from the party” (to slow the economy) when it gets a bit too rowdy

2) administer preventive “medicine” to its patient (the U.S. economy) when necessary in order to minimize the chance of a more serious “inflation disease” later, which would require even more drastic action (more painful medicine)

Note: Most changes to monetary policy are enacted by the Fed adding reserves to or withdrawing reserves from the banking system through a process called open market operations. The result of such moves is to increase or decrease the Fed’s most critical interest rate, the federal funds rate. The federal funds rate is the rate at which commercial banks and certain other financial institutions invest excess funds with other commercial banks on an overnight unsecured basis.

The federal funds rate is easily the most important of ALL short-term interest rates. Changes in the federal funds rate immediately impact the level of all other short-term interest rates, including the prime lending rate and various short-term investment rates. The discount rate, the other rate controlled by the Fed, is now almost irrelevant in today’s conduct of monetary policy.

The “Dog” and the “Tail”

While many of the Federal Reserve’s official responsibilities remain unchanged from earlier years, the nature of the Federal Reserve’s monetary policy flexibility has changed markedly during the past 25 years. In my opinion, the Federal Reserve is no longer the primary determinant of when monetary policy changes are necessary–the U.S. bond market is.

Since the Federal Reserve’s creation in 1913 until perhaps the late 1970s, the Federal Reserve solely determined monetary policy. The nation’s bond market–much smaller during those times–then quietly fell in line. During that era, the Federal Reserve was the “dog,” while the bond market was the “tail.” This relationship has now reversed.

Today’s reality is that the Federal Reserve, to a large extent, provides the monetary policy mix that is demanded by a powerful and very inflation-sensitive bond market. The market is now the “dog,” while the Federal Reserve is the “tail.”

Today’s inflation-wary bond market provides the Federal Reserve with less monetary policy flexibility than at any time in its history. Any future Federal Reserve attempt to over-stimulate U.S. economic growth with “easy money” would be met with rising long-term interest rates (to protect lenders/investors from impending higher inflation) and cries of Federal Reserve irresponsibility.

Conducting Monetary Policy

How is proper monetary policy determined by the Federal Reserve? The Fed is clearly concerned about the inflation implications of today’s historically tight labor markets and the wage pressures that could result.

In addition (and figuratively speaking), today’s Federal Reserve conducts monetary policy using an old-style balancing scale with four trays.

In separate trays, the Fed balances:

1) Criticism from the “hawks,” who see inflation under every rock. The hawks are typically critical of the Fed, noting that the institution is not aggressive enough in diffusing inflationary expectations

2) Criticism from the “doves,” who constantly argue that monetary policy is too restrictive. The doves argue that the Fed has usually gone too far in monetary tightening or not eased policy enough, and that the Fed frequently threatens the economy with the “r” word…recession

3) Recent price performance of gold and various other commodities. Price movements in these commodities can serve as inflation red flags, as well as signs of monetary policy that is too restrictive

4) The current shape and slope of the U.S. Treasury yield curve, including the most recent direction of 10-year U.S. Treasury Note and 30-year U.S. Treasury Bond yields. Such information provides a clue as to the bond market’s collective view of inflation expectations

Only when all trays are in “relative balance” does the Fed consider monetary policy to be appropriate.

The Fed must also consider the inflation implications of U.S. dollar strength or weakness relative to other global currencies. The Fed must also consider the conduct of monetary policy by other major central banks including the European Central Bank, the Bank of England, and the Bank of Japan…

…not a task for the faint-hearted

Economic futurist Jeff Thredgold is President of Thredgold Economic Associates, a professional speaking and economic consulting company.

Since 1976 Jeff’s weekly economic and financial newsletter, Tea Leaf, has been helping people make sense of the tangled maze of the U.S. and global economy and financial markets in a light, approachable style. Sign up to receive the free Tea Leaf email newsletter and let Jeff Thredgold show you how to use this information to enhance your financial well-being for years to come.

Jeff is the author of econAmerica: Why the American Economy is Alive and Well…and What That Means to Your Wallet (Wiley, 2007), and On the One Hand…The Economist’s Joke Book.

His career includes 23 years with $96 billion banking giant KeyCorp, where he served as Senior VP and Chief Economist. He now serves as economic consultant to $50 billion Zions Bancorporation, which has banks in 10 states.

Observing the movement of stock prices in Japanese Candlestick format and in real-time depiction is somewhat akin to watching the printout of an electrocardiogram in motion. One is seeing at first hand the story of an unfolding investor psychology. The first practitioner of Candlestick price representation, so many centuries ago in Japan, was no doubt seeking to develop a strategy or a system of tactics which would deliver to him a trading advantage which would assist him in planning his next moves. The technique of price recordation which he developed was based on the principle of expanding the “line,” or “bar,” on a chart representing the range of prices for a given time period so as to create a fattened-out line, or cylinder, in which the opening price and the closing price for that time period would be the upper and lower limits of the cylinder. If the closing price of the day were higher than the opening price, then the cylinder would not be filled in, or would be left “white;” whereas if the closing price of the day were lower than the opening price, then the cylinder would be filled in, or made “black.”

This style of price display presented a visual picture which was instantly recognized by the eye. It was easy to discern the mood of the rice traders which was in effect during that session; and, depending on the relationship of that particular Candle bar’s relationship to adjacent and nearby bars, the operator had a basis for making a prediction of the direction of prices for the next day.

Furthermore, when interpreted properly in the light of human judgment, the shape of a bar, especially when considered in conjunction with adjacent or nearby bars, was found to possess an ability to forecast a reversal of major trend.

After long and expensive historical research and translation of old records into English, the Candlestick approach to price charting was brought to the Occidental world about 25 years ago. In the early years, the Candles developed a following only very slowly. More recently, however, professional traders and investors, as well as those who do not trade or invest for a living, have begun to appreciate the advantages of the Candlesticks, to the point at which it seems reasonable to predict that they will be the standard within the foreseeable future.

What is so unusual about the Candles? In short, they form patterns which have meaning in terms of revealing traders’ theretofore-hidden investment rationale, and also in terms of allowing forecasts to be made regarding the future course of price action. Some of these visual formations or images are useful in foretelling the end of a trend and a possible topping out and rollover to the downside (if the major trend has been one of increasing prices) or of bottoming out and rolling to the upside (if the major trend has been one of declining prices).

At the top of an extended rising market, one of the more dependable reversal patterns is the “Evening Star,” a three-bar pattern in which the first bar is a tall white bar; the middle bar is a small “Star” which usually sits higher than the first bar; and the third bar is a tall black candle which usually sits lower than the Star. This formation is bearish in its implications; and the implication is strengthened if the Star is a “Shooting Star,” which looks like its namesake. At the end of an extended declining market, the inverse pattern can also appear; and, perhaps not unexpectedly, its name is the “Morning Star.”

The opposite of the Shooting Star is the “Hammer,” which appears only at the end of an extend downtrend. The Hammer is considered to be one of the more reliable predictors of a possible change of trend to the upside, especially when the next day’s closing price is higher than the closing price of the Hammer.

A “Doji” is a price bar in which the opening price and the closing price are the same. It is considered to be an indicator of a reining-up - of indecision - and of a possible change of trend, when it appears at the end of an extended move in either direction. A Star whose opening price and closing price are the same is called a “Doji Star.” A “Bearish Engulfing” pattern occurs at the top of an uptrend, and is marked by the “real body” (i.e., the cylinder in the price bar) engulfing the real bodies of one or more previous bars. The “Bearish Engulfing” formation is, quite naturally, bearish. Its converse is the Bullish Engulfing pattern, which occurs at the bottom of a downtrend; and, obviously, carries a bullish signal.

In Candlestick parlance, gaps (”windows”) are celebrated as being generators of support and resistance. Often, a comparison of price action before and following a gap clearly reveals the power of a gap to repel prices which venture within it.

The Candles are useful in any time frame, including day trading. Although they are valuable in foretelling reversals, they do not predict the extent of a move. They are perfectly compatible with all “Western” Indicators, and the synergy which often results from the Candles and the Western Indicators used together can be remarkable. Furthermore, the Candles are equally adaptable to use in every financial market, including stocks, indexes, commodities, and Forex.

Technical analysis of Japanese Candlestick price imaging is founded on the hypothesis that price action in the financial markets is not random or mechanical; rather, that it is patterned (if the practitioner is following Elliott Wave theory), and that it is the result of human emotion in action.

There are many practitioners of Candlestick analytics who make their services available to the investing public. Some of them publish investment advisory newsletters (alternatively called “investment newsletters” or “market letters” or permutations thereof); some offer instructional and training seminars, forums, and chat rooms; some publish books; and some of them offer multiple services and products. Their observation of the Candlestick world sometimes leads to a critique of the common wisdom as propounded by the media, and to explicit review of, and commentary on, the state of the markets. Expostulation of the Candlestick analytical technique is not commonly a part of financial news programs, either in the popular printed media or on television; nor are the particulars of Candle theory often the subject of study, research, investigation, or illustration for the benefit of the investing public.

This is unfortunate, because the information which flows from these concepts could often open up new possibilities for investors and be of value to them in their decision making process.

http://www.candlewave.com