S&P 500 Volatility Belies Confidence Ahead of Fed

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

  • The Trade Perspective: S&P 500 Bearish Below 4,100 After FOMC; USDJPY Bearish Below 129; GBPAUD Bullish Above 1.79
  • While US indices have started off the week and month with a modest gain over Friday’s close, the interim volatility suggests considerable instability ahead of the Fed
  • Liquidity is as much a consideration for the next 24 hours of trade as anticipation for Wednesday and any scheduled event on tap for Tuesday

High Volatility Suggest Things are Not ‘Alright’

For those bullish-biased market participants looking for any sense of relief following last Friday’s tumble, Monday’s eventual bullish close was a source of relief. However, I would not look at the modest gains for the S&P 500 – or even the more material 1.7 percent jump on the Nasdaq 100 – as a gauge for conviction. Instead, the extraordinary volatility through the course of this past session stands out to me as a hallmark of the conditions we are dealing with rather than day-to-day change. The past session’s range for the SPDR S&P 500 ETF (arguably the most heavily invested-in derivative in the world) was only modestly smaller a percentage of spot than Friday’s peak – which often occurs around lows. Furthermore, the intraday reversal that produced the ‘lower wick’ for the session was the largest since January 24th while volume was the heaviest since March 8th. There is tumult underlying this market and that does not bode well for a committed recovery effort in the face of an existential threat like Wednesday’s FOMC decision.

Chart of SPDR S&P 500 ETF with Volume, 50-Day SMA, ‘Wicks’ (Daily)

Chart Created on Tradingview Platform

The Wednesday afternoon US central bank rate decision will draw our attention forward and overshadow many other fundamental developments until that event exacts its toll on the market. Such a high-level event with unprecedented capacity for potential global market impact will naturally cast other matters in shadow until it the fundamental eclipse passes. More than quiet other points of event risk, the skew in liquidity can create difficult trading conditions for those that don’t account for the distortion. For example, those looking for conviction through lasting and productive trends (for me that stretches from multiple days to multiple weeks) are going to be casting their views to the wind for the time being. An example of the extreme polarity that can occur in this kind of situation was ‘conveniently’ illustrated by the flash crash in Nordic equity markets Monday. A supposed ‘fat finger’ on a Citi trading desk pushed an accidental, large sell order into a market thinned by London’s absence due to the holiday – though the near-7 percent plunge in 5 minutes was quickly reversed. This was an unusual occurrence, but our current conditions can raise the risk of further similar situations.

Chart of OMS 30 Stockholm Index with ‘Wicks’ (Daily)

Chart Created on Tradingview Platform

The Dollar May Be a Rare Exception…For Obvious Reasons

While the liquidity conditions we are dealing with heading into this new trading week and month may be generally universal, not all benchmarks are going to find themselves at the whims of positioning. The Dollar is proving remarkably resilient despite its scaling lofty heights on exceptionally Fed rate forecasts. The trade-weighted DXY Dollar Index closed slightly below Thursday’s highest daily close in nearly 20 years. This is not a recent check higher, rather the benchmark currency has charged higher for 17 out of the past 20 trading days (the span of a technical ‘trading month’). If there were ever a market that can be argued to be primed for a ‘correction’, it would be the Greenback. That said, if there isn’t any meaningful pressure relief before the event Wednesday, it could very well amplify any ‘disappointing’ outcomes from the policy decision after the fact.

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

Chart Created on Tradingview Platform

Visualizing how the Fed meeting could play out tomorrow (Wednesday) afternoon, I have made the below scenario table. The decisions from the central bank are easy enough to theorize, but the market’s response to such events is very difficult to evaluate. At present, the Fed Funds futures market is essentially fully pricing in a 50 basis point rate hike this week which wouldn’t surprise anyone that has been listening to the many Fed member warnings we have registered over the past week. However, the point of immediate contention can likely be encompassed in the incredible 88 percent probability of a subsequent 75 bp rate hike at the June 15th meeting. That is serious confidence on a move by the central bank that has not been seen in many, many years. Given the United States position in the global picture and the Fed’s role in leading monetary policy, it’s not hard to understand the potential impact of this particular event.

Scenario Table for May 4th FOMC Rate Decision

Chart Created by John Kicklighter

The Event Risk Between Now and the Fed

While I will reserve my expectations for full capacity trends until the FOMC decision passes, that doesn’t mean the fundamental world will simply halt. Just this past session, an important fundamental update for the US economy, the ISM manufacturing survey for April, unexpectedly dropped. Factory activity in the world’s largest economy slowed to its most constrained pace of growth since July 2020 – an unflattering comparison given the state of the pandemic-led shutdown. A drop in activity, orders and employment does not bode well for the economy; but perhaps there is cold comfort in an easing in prices. I will say though that this is a better measure in the US of supply chain issues while (Wednesday’s) service sector report is a more pointed reflection of the general economy and the labor market. Meanwhile, monetary policy will be on the mind with the Eurozone employment and factory inflation on top of mind with market’s pricing in 80 basis points of ECB tightening through year-end, but I don’t expect serious rate speculation there. I can’t say the same for the RBA rate decision aftermath.

Calendar of Major Economic Events

Calendar Created by John Kicklighter

For the next 24 hours, there is no more impactful and direct an event than the RBA rate decision. A hike is generally expected, but the scale is up for serious debate. There is some outlier expectation that a 50bp move commensurate to what has been projected for the Fed, BOC and BOE is on tap. Yet, more consistent with the data are forecasts for either a 25bp or 10bp tightening. Looking at swaps, the latter is priced for this meeting, but a total of 251 basis points are priced through year’s end. That is aggressive. If a mere 10 bp move is realized without sating expectations of a sharp acceleration, it is reasonable to expect a pull back on from the Aussie Dollar. The problem is that the currency has not been particularly aggressive against many counterparts in the past days and weeks. I like evaluating counterparts that are equally underappreciated, and for me that is the Sterling. GBPAUD is an interesting pair for technical and fundamental purposes.

Chart of GBPAUD with 50-Day SMA (Daily)

Chart Created on Tradingview Platform