S&P 500’s Post-Fed Rally Collapses – Will 4,300 or 4,000 Fall First?

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S&P 500, Dollar, GBPUSD and Monetary Policy Talking Points

  • The Trade Perspective: S&P 500 Bearish Below 4,000; GBPUSD Bullish Above 1.0650
  • The contradictory rally from the S&P 500 and other risk assets following the FOMC’s hefty 50bp rate hike and QT announcement has been snuffed out
  • The heft of scheduled event risk will ease moving forward, but the market will be more tuned to monetary policy and growth implications speculation that erodes the ‘buy the dip’ confidence

The Short-Term Relief Rally Past, What Direction Do the Markets Take Now?

The post-FOMC rally for the S&P 500 and other risk-leaning benchmarks defied traditional assumptions of fundamental value. Yet, that short-term correction seems to have run its course, allowing the deeper implications of a drain in monetary policy support against a backdrop of fading growth forecasts to truly sink in. Why did the US indices and general backdrop of risk appetite rise in the face of the biggest Fed rate hike in 22 years? Because the market was holding open the probability that an even more onerous 75 bp rate hike would follow at the next meeting on June 15th. Notably, the market didn’t start its rally after the rate decision itself, rather the charge started after Fed Chairman Powell verbally rejected the idea that the group was considering such an aggressive move. Avoiding such a grand rate increase and instead sticking to consecutive meetings of 50 bp hikes is not really the foundation for speculative enthusiasm, but it is reason enough to spark covering on more aggressive short interest. That seems to be how the market played these cards considering the massive 3.0 percent S&P 500 rally on FOMC Wednesday was followed by a -3.6 percent tumble on Thursday to completely wipe out the gains. We have worked through the Fed’s next milestone and the attention now shifts back to data points and speculation – an inherently volatile mix. Meanwhile, Fed Fund futures are still pricing in an 87 percent probability of a 75 bp hike next month. Keep an eye out for central bank messaging next week.

Chart of S&P 500 with 20-Day SMA and 1-Day Rate of Change (Daily)

Chart Created on Tradingview Platform

While the S&P 500 – as a guide for sentiment – can absolute see moves higher moving forward; the fundamental backdrop seems particularly fraught given the significant downgrade in global growth mixed with the frequent reiteration from monetary policy authorities (not just the Fed) that they intend to normalize even if the markets throw a fit. For anyone keeping score, the dramatic swing over Wednesday to Thursday registered the greatest realized volatility – calculated as a 2-day ATR as a percentage of spot – since June of 2020. Yet, through all of that activity, the market has not cleared more hardened technical boundaries between 4,300 to the upside and 4,000 looking lower. A bullish break would be heavily burdened in my view by the fundamental troubles on hand. Making serious progress back towards record highs when growth and leverage are being reigned in is at the very least going to be a choppy endeavor. Alternatively, the build up over the past two years of post-pandemic climb – and arguably 13 years of post-crisis build up – leaves plenty of premium to be cut down. On the technical side, the weekly chart encompasses the picture well. There is a large-scale head-and-shoulders pattern following a remarkable rally (I firmly believe such reversal patterns should have something significant to reverse) with an aggressively slopping neckline that has significant overlap around 4,040/00.

Chart of S&P 500 with 20 and 100-Week Moving Averages (Weekly)

Chart Created on Tradingview Platform

I put the question of whether the market would be moving higher or lower over the coming two weeks immediately following the Fed decision. The majority of those that voted did so amid the relief rally responding to the ‘curbed 75 bp hike outlook’, which have drawn out the more speculative view. Notably, the group that believed the bull trend would reassert itself through the middle of May were in the minority at 28 percent while the bears came out in force with 55 percent of the vote (the balance was a neutral view). Despite the time frame of two weeks, it is the skew among retail traders that they think far more near term when projecting direction. When it comes to truly re-establishing a perspective amongst the speculative rank, I believe a break of either 4,300 or 4,000 would be a reasonable cue. For statistical context, the forthcoming 19th week of the year averages out to be a modest gain for the S&P 500 over the past century while the 20th week is averages the second worst plunge in the market of the calendar year.

Poll Asking Whether the S&P 500’s Rally Continues, Stalls or Reverses in Two Weeks

Poll from Twitter.com, @JohnKicklighter

Monetary Policy Speculation Will be a Principal Theme Moving Forward

If you are looking for what theme will be driving the market moving forward, there are a handful of systemically important matters that will likely factor in. That said, I believe the interconnected web will trace back to monetary policy in some form or another. Where there are independent matters with potential for acute volatility like the Russian invasion of Ukraine, you still have a ready thread back to monetary policy – the likely charge in energy and agricultural commodity prices along with the negative implications for economic activity. And, just to prove this is not just a matter to be applied to the US currency and markets, it is worth highlighting the performance of the Sterling this past session. The Bank of England hiked rates (25 basis points) for the fourth time in six months, which is a remarkably persistent hawkish path relative to counterparts. Nonetheless, the Pound dove after the announcement in large part due to the forecasted contraction in the UK economy by year’s end. Not only did GBPUSD suffer a drop comparable only to he height of the pandemic or Brexit, but the Sterling would also drop sharply against overtly dovish counterparts like EURGBP. Meanwhile, the FTSE 100 was registering the weight via capital markets.

Chart of GBPUSD with 20-Day and 200-Day SMAs (Daily)

Chart Created on Tradingview Platform

There are two side to the fundamental influence of monetary policy: the relative yield implications that fuels exchange rates and the collective view for speculative appetite. On the former matter, I’m watching pairs like EURUSD. While the Fed’s hawkish credentials are unquestionable at this point for me, the ECB’s dovish posture is under threat. That is not a particularly new state of affairs, but officials from the exceptionally dovish group have made a Fed-like effort to message a hike sometime in July, Summer or early August. That doesn’t close the gap to US rates much less their tempo, but it could render EURUSD stretched to the downside. As such, 1.0635 will be on my radar. Through the lens for global risk trends, the downturn in aggregate stimulus – much less the market’s registering the meaningful slide – will happen fairly slowly. Nevertheless, we are talking about forward looking markets where speculation will project intentions and adjust accordingly. As I’ve said before, the greatest fuel for risk aversion in my book would be the collective recognition that despite a given market slide, the Fed and others will stick to their word that no policy support will be proffered as it had been in the past.

Chart of S&P 500 Overlaid with Aggerate of Major Central Banks’ Balance Sheets (Daily)

Chart Created on Tradingview Platform

The Major Event Risk Ahead

If I am adhering to the believe that most thematic views for market development will return to monetary policy speculation, then the event risk on tap that can be interpreted for its central bank influence will prove the most provocative for movement. As it happens, insight into the both sides of the Fed’s dual mandate – full employment and steady, moderate inflation – is scheduled for release ahead. The April NFPs and overall labor data run will take on a greater weight as the US central bank has all but treated employment as if it is a certain fixture in the policy calculation. While a singular miss on this data won’t likely send rate forecasts reeling, it could very well chip away at conviction. Alternatively, I don’t believe there is much more room to push a hawkish view. Next week, we have the inflation picture covered with the US consumer inflation expectation update on Monday and the official CPI on Wednesday. Sprinkle in between these key reports a smattering of Fed speak, and it seems like the US policy mix will continue to be something we not only talk about, but evaluate our believe system around.

Calendar of Major Economic Events

Calendar Created by John Kicklighter