Trends

The trend is your friend; but when does it end?

Here's a look at the Federal Funds Rate since the mid-80's.  The rate has gone through several cycles since an arbitrary start date of 1984, chosen to get a good close-up view of action over the period.   The Fed changes the FFR whenever they feel like it, so the data points are not evenly spaced.   The FFR is shown in blue, a 21 point exponential moving average* in yellow, and an envelope + and - one standard deviation - based on the same 21 points - from the average in red and green, respectively.

My Excel data file doesn't say where the data came from.  Shame on me for carelessness.  It may have been from FRED.   If you're interested in the data and calculations, send me an email, and I'll send you the file.

The FFR goes on excursions, and spends a lot of time hugging one of the envelope boundaries.  When it makes a move back inside the envelope by crossing a red or green line, it typically indicates a change in direction is about to occur.   For this data set, crossng the red line appears to be more relaible than crossing the green line.

No indicator is perfect.  Green line cross-overs give a couple of false signals, circled in purple.  In each case, though, a real change did follow, eventually.  In the first case, July, '85, the real shift was over a year later, in Dec. 1986, and about 1.5% lower.   The Jan. '02 false signal was about 12 months early, and .3% high from the real cross-over, and .55% above the ultimate bottom.

Using signals together can be helpful.  Here is the FFR again, this time shown with the Standard Deviation, multiplied by 5 to put it on a comparable scale.

Not every bottom in the StD corresponds with a bottom in the FFR.  But, every bottom in StD that follows a green line cross-over does signal that the FFR is about to turn up.  Note that the July, '85 crossover occurred when the StD was high and rising.   There is a little blip in StD in the second half of '03, concurrent with the start of the ultimate bottom, a flat spot around 1% running from July, '03 through May, '04.

These two signals working together gave a very reliable indication of trend changes over a period of two and a half decades.

We are now in a region that is unprecedented.  The FFR is hugging 0, and so is the StD.  These things can only go up from here; but who can say if or when it will ever happen?   Since the FFR topped in 1981, it's been a series of lower highs and lower lows.  The lows have hit bottom.  Highs - should we ever get any - could possibly continue to trend lower.

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* The problem with a simple moving average is that every early point in your data packet has the same weight as the most recent one.   An exponential moving average weights the most recent data point.  A series of points thus weighted skews the average towards the most recent action.   Any moving average is backward looking - there's no help for that.  But an exponential moving average increases the importance of recent data, and yields a more responsive, quicker moving average line.