Will the Fed’s shock interest rate cut save the stock market?

March 05, 2020 12:30

Central banks are becoming increasingly worried about the potential for a coronavirus 'pandemic'. As more and more cases are being reported around the world, markets have looked towards central bankers to act and support the economy. Surprisingly, the US Federal Reserve did act by cutting interest rates on Tuesday 3rd March. Can this save the stock market? Let's find out.

The Fed, interest rates and the stock market

When the economy is slowing down, or there are foreseeable risks to economic growth - such as the coronavirus - central banks tend to cut interest rates to stimulate financial activity. On Tuesday 3rd March, the Fed enacted the biggest single interest rate cut since October 2008 - the start of the financial crisis. The aim is to get consumers and businesses spending and investing more which in turn boosts stock prices.

The Fed rate cut has been met with mixed reaction. Robert Eisenbeis, a former top Fed economist said it was a waste. David Kelly, chief global strategist at JP Morgan Asset Management said that it's not clear whether this standard monetary remedy is the right cure for an epidemic-induced economic downturn.

However, some believe that the Fed needed to act as - if they did not - that would have caused even more panic in the markets. What's clear is that the market is in unchartered territory right now. What's more interesting is that global stock markets hardly reacted to the biggest interest rate cut since 2008. In fact, stock markets tumbled on the news only to push up a little bit higher the next day on news that Joe Biden is a potential frontrunner for the Democractic presidential bid.

Let's have a look at the Dow Jones 30 Index (DJI30) to see how the market has responded.

How to Trade the Dow Jones 30 Index (DJI30)

The long-term monthly chart of the DJI30 below highlights the long-term trend of the market:

Source: Admiral Markets MetaTrader 5, DJI30, Weekly - Data range: from 5 March 2006 to 5 March 2020, accessed on 5 March 2020 at 10:56 am GMT. Please note: Past performance is not a reliable indicator of future results.

With Admiral Markets you can speculate on the price direction of the Dow Jones 30 index (DJI30) by using a CFD (Contract for Difference) which allows traders to go long and short on the market.

It's clear to see the recent sharp drop in the DJI30. This has mainly been led by the economic impact of the coronavirus. From a long-term perspective, however, it is clear to see historical buying that has taken place around the green wavy line which is the 200 exponential moving average. This area could be a buying opportunity for many long-term investors.

Let's go down to the lower timeframe to see the recent price action in more detail.

Source: Admiral Markets MetaTrader 5, DJI30, Daily - Data range: from 3 October 2018 to 5 March 2020, accessed on 5 March 2020 at 11:06 am GMT. Please note: Past performance is not a reliable indicator of future results.

In the above daily price chart of the DJI30 the recent sell-off stopped at the lower blue horizontal line, around 24,700. Since then, however, the move higher has been relatively small compared to the sell-off, even after the Fed rate cut. The upper blue horizontal line on the chart, around the 26,720 price level is a key battle area for buyers and sellers.

  • If the coronavirus shows no signs of abating, this may be an area where sellers will initiate fresh short positions to push the market lower - perhaps back to the lower blue horizontal line at 24,700.
  • If the coronavirus shows signs of a slowdown in spreading throughout the world it may cause buyers to enter the market once again. In this case, we would need to see price trading back above the 26,720 price level.

Lower timeframe traders may even look at the hourly chart for more information on who is likely to win the battle - buyers or sellers.

Source: Admiral Markets MetaTrader 5, DJI30, H1 - Data range: from 12 February 2020 to 5 March 2020, accessed on 5 March 2020 at 11:16 am GMT. Please note: Past performance is not a reliable indicator of future results.

In the hourly price chart above, price action has started to consolidate as no buyers or sellers are ready to take control of the market. This has formed a wedge chart pattern formation, as shown by the descending and ascending blue lines. Traders will be looking for a breakout of one of these levels for an early sign of who is taking control of the market.

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