Fed Rate Hike Strategy for Dollar, S&P 500 and Gold

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S&P 500, Dollar, Fed Decision and GBPUSD Talking Points

  • The Trade Perspective: S&P 500 Bearish Below 4,100 After FOMC; USDJPY Bearish Below 129; GBPAUD Bullish Above 1.79
  • The FOMC rate decision is top event risk for the upcoming session with a 50 basis point rate hike and announcement to start ‘quantitative tightening’ priced in
  • We discuss where markets are due to respond to this event risk, what scenarios we probable and a threat assessment the S&P 500, the Dollar and Gold

The US central bank (otherwise referred to as the Federal Reserve) is due to announce its update on monetary policy at 18:00 GMT Wednesday afternoon followed a half hour later by Chairman Jerome Powell’s press conference. This event is very significant for the US and global markets, both through the short and long-term. What the monetary policy authority decides for the world’s largest economy represents a meaningful economic and financial impact for the country itself. Yet, far more significant is the signaling power it represents for the monetary policy mix for the global system. In other words, if the Fed lights the way for an aggressive tightening regime; many major and minor counterparts are likely to follow in the effort to fight inflation and/or curb the impact of heavy (USD) exchange rate pressures. In practical terms, a rate hike is fully baked into the markets. In fact, the markets are pricing in a near certainty (99.8 percent probability) of a 50 bp hike to a 0.75-1.00 percent range. That would be the first half percentage point increase from the policy group since May 2000… Nevertheless, the historical significance of the increase is not likely to exact the greatest toll on the markets. Instead, the elements that feed into the pace following this particular meeting is where the speculation will really register its impact. At present, Fed fund futures are pricing in an incredible 96 percent probability that the central bank will increase its benchmark rate by another (so inclusive of a 50 bp hike today) 75 bp at the June 15 meeting. That is aggressive and unprecedented for decades. To reinforce that view would provide the unexpected backdrop to further the already extreme speculation, but to reasonably fall short could provide justification to walk back some extremes.

Scenario Table for May 4th FOMC Rate Decision

Chart Created by John Kicklighter

Risk Trends – And Specifically the S&P 500 – Scenarios for the Fed

While I am monitoring the US Dollar and yields as important relative measures that are prone to the FOMC rate decision, my principal interest is in the benchmark ‘risk’ measures. When it comes to investors sentiment, my assessments can be complex and run wide. However, there is no more direct a measure of the past 14 years of monetary policy than general capital market measures like the US indices. I would say that there is a significant accounting for the hawkish forecast already incorporated into the current market bearings. Even excluding the added volatility of the Russian invasion of Ukraine, the S&P 500 is leaning heavily lower (approximately -15 percent) while the Nasdaq 100 entered an official bear market in 2022. Fundamentally-speaking, we have accounted for a significant tightening moving forward. That said, I don’t believe this pressure is truly indicative of the full scope of an 88 percent probability that the benchmark rate will be at or above 3.00 percent by the end of the year…

Chart of S&P 500 with 20-Day SMA (Daily)

Chart Created on Tradingview Platform

While I know a lot of investors eschew the importance of technical analysis, there is a lot to read in the heavy lean indicative of the weekly S&P 500 chart. We are not that far from the record highs touched at the very start of the year, but the progression in the subsequent retreat should be familiar to technical traders. What we see on the higher time frame chart is a head-and-shoulders pattern. Consider some of the critical elements to such a high-profile pattern. First and foremost for me is the absolute need that there is a prevailing trend that could potentially be reversed – this is an element that is far too often overlooked. Furthermore here, we find that the ‘neckline’ is sloping lower which suggests pressure for a reversal. What’s more, there is weight to the 4,050/20 support that is a midpoint of the 2H 2020 to all time high range and the 100-week moving average. I would be unimpressed by the chart pattern alone; but the implications of a market caught far too extended truly piques my interest.

Chart of S&P 500 with Volume, 20 and 100-Week SMAs (Weekly)

Chart Created on Tradingview Platform

The Dollar and Gold Are Measures That Should be On the Top Threat Assessment List

While I’m watching the S&P 500 as a benchmark of general risk trends heading into – and certainly after – the FOMC rate decision, the relative value implications carry just as much fundamental weight. For the US Dollar, we have already seen an incredible charge through the past year, with a particularly acute acceleration just over the past few months. The trade-weighted DXY Dollar Index has rallied to 19-year highs with incredible individual gains versus the Euro, Yen and British Pound. At these heights, it is safe to say that it is pushing remarkable heights, but that doesn’t mean that this has to be a traditional story of ‘buy the rumor, sell the news’. If the either the FOMC monetary policy statement or Powell remarks further the aggressively hawkish forecast moving forward, the Dollar could very well gain even further.

Chart of DXY Dollar Index with 100-Day Moving Average and Consecutive Candles (Daily)

Chart Created on Tradingview Platform

Moving away from the traditional ‘currency versus currency’ evaluation, another market that is worth including in the critical circle of analysis is gold. The precious metal has already slipped through below the midpoint of the past two years’ range already this week, but there is still plenty of room to move all the down to the 2020 and 2021 range lows (approxoimtely 1,670) without truly break in favor of the bears. Gold is considered a safe haven in some circles but it also assigned a value that tends to benefit when traditional currencies at large are under pressure. But what happens with this commodity when interest rates are seen rising universal and all currencies enjoy the lift? In a higher rate environment, the very pointed lack of returns gold provides in futures and other instruments, drives interests elsewhere.

Chart of Gold Futures with Volume and 20-Week SMA (Weekly)

Chart Created on Tradingview Platform

Other Top Event Risk

While all the focus is currently on the FOMC decision – as it should be – it is important to recognize that this particular update isn’t the end-all of the markets. When the uncertainty from the US central bank is clarified in policy actions, we will see speculative channels spread to evaluate other, under-appreciated quantitative measures like the general health of the economy. Monday saw the release of the ISM manufacturing report which showed easing in orders and employment – with a moderation to prices paid. Notably, the factory report suggested supply chain issues are a serious threat recent record highs. If you are looking for a more indicative view of US GDP, the ISM service sector represents the best proxy for output and employment. Otherwise, the Brazilian and Bank of England rate decisions will likely

Calendar of Major Economic Events

Calendar Created by John Kicklighter