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US Dollar & VIX Supported; Stock Market Rally at Wits End?

US Dollar & VIX Supported; Stock Market Rally at Wits End?

Rich Dvorak, Analyst

STOCK MARKET FORECAST – US DOLLAR & VIX ‘FEAR-GAUGE’ BOLSTERED AS EQUITY RECOVERY LOSES MOMENTUM; S&P 500 INDEX, DOW JONES, NASDAQ & RUSSELL 2000 AT RISK

  • US Dollar stretches higher as unemployment continues to mount, FX volatility snaps back and the recent wave of coronavirus optimism stalls
  • S&P 500 price outlook grows increasingly bearish along with the Dow Jones, Nasdaq and Russell 2000 owing to the latest coronavirus update
  • The VIX Index ‘fear-gauge’ popped on news the SBA Payroll Protection Program ran out of funding while stock market earnings season disappoints and crude oil remains under pressure

US Dollar strength lingers as sticky volatility readings keeps the DXY Index bolstered. US Dollar upside recorded so far this year has been driven largely by demand for safe-haven assets, which has boosted the Greenback despite unparalleled monetary policy stimulus from the FOMC. Gains in the US Dollar this week against major peers – such as EUR, GBP, JPY, CAD and AUD – seems to accompany a mood shift away from improving market sentiment as the US stock market rally loses momentum.

US DOLLAR – DXY INDEX PRICE CHART: DAILY TIME FRAME (SEPTEMBER 2019 TO APRIL 2020)

DXY Index US Dollar Forecast Coronavirus

Chart created by @RichDvorakFX with TradingView

Also, the DXY Index appears to have found technical support around the 99.00 price level, which is highlighted by the confluence of its 50-day simple moving average, October 2019 swing high, and mid-point retracement of last month’s bullish leg. From a fundamental perspective, the latest coronavirus developments have likely rekindled demand for safe-haven currencies and US Dollar dominance. Specifically, investor risk appetite soured on the back of news that several countries are prolonging their coronavirus lockdown.

Evidence that coronavirus containment efforts have succeeded at flattening the curve – owing to a deceleration in the growth of confirmed coronavirus cases, hospitalizations and deaths – prompted traders to turn optimistic over the last couple weeks that government lockdowns will soon end. As the latest coronavirus updates detail that lockdowns are getting extended instead of lifted, however, that doesn’t seem to be the case.

This stands to continue weighing negatively on global GDP growth forecasts that have already experienced deep downward revisions as economic costs from the coronavirus pandemic mount. Specifically, the IMF just released its update to World Economic Outlook for 2020, which forecasted a -3.0% contraction in global GDP growth, but the organization also predicts a +5.8% rebound next year. That said, the prospect of a ‘V-shape’ recovery in the global economy and business activity seems increasingly less likely.

This is considering stimulus efforts from central banks and governments around world could fall short as economic fallout from the coronavirus swells. Correspondingly, there might be potential for the US Dollar to rise and steer the DXY Index back toward year-to-date highs near the 103.00 price level. At the same time, major stock market benchmarks, such as the S&P 500 Index, Dow Jones Industrial Average, Nasdaq or Russell 2000, could experience another sharp selloff as investor complacency comes to terms with economic reality.

MARKET VOLATILITY – VIX INDEX PRICE CHART: DAILY TIME FRAME (SEPTEMBER 2019 TO APRIL 2020)

VIX Index Price Chart Volatility Stock Market Forecast

Chart created by @RichDvorakFX with TradingView

Market participants have already started to show signs that their recent influx of coronavirus optimism has waned. This is indicated by a pop in the VIX Index, or ‘fear-gauge,’ which happens to mirror a spike in implied currency volatility. Ominously, the recent uptick in expected FX volatility and S&P 500 volatility seems to resemble the volatility explosion traders witnessed throughout February and March.

On that note, with investor outlook mired by the juxtaposition of unprecedented stimulus measures contrasted against the sharpest economic downturn in modern history, recent US Dollar and VIX Index price action might serve as a bellwether to where the stock market heads next. If measures of volatility continue churning higher from current levels, it may bode poorly for the bear market rally recently notched by US equities.

Similarly, as COVID-19 plagues the US labor market, the series of alarming datapoints for initial jobless claims has wiped out employment gains recorded since the prior global financial crisis in a matter of just four weeks. The knock-on effect from 22 million Americans who have lost their jobs, which could be materially understated considering the lack of capacity by local governments to process this unfathomable amount of unemployment insurance claims, seems overlooked by the majority of investors who have pushed the S&P 500, Dow Jones, Nasdaq and Russell 2000 roughly 20% above their March 23 swing lows. Though investors seem quick to cheer rumored progress made toward an effective coronavirus treatment and/or vaccine, which arguably could facilitate a fast economic recovery.

STOCK MARKET FORECAST REMAINS PESSIMISTIC – S&P 500, DOW JONES, NASDAQ, RUSSELL 2000 MIGHT RETEST LOWS DRIVEN BY ANOTHER CORONAVIRUS SELLOFF

S&P 500 Price Chart Stock Market Forecast Coronavirus

Chart created by @RichDvorakFX with TradingView

Yet, it was just announced that the SBA Paycheck Protection Program, perhaps one of the more supportive and important fiscal stimulus efforts undertaken by the US Treasury, is no longer accepting rescue loan applications after depleting all of the $350 billion earmarked to ease recent financial strain on small businesses. This situation could likewise be extrapolated to the $2 trillion coronavirus relief bill and $1,200 cash windfall per adult expected. Although helpful in offsetting the economic turmoil faced by Americans due to COVID-19, the stimulus checks likely pale in comparison to lost income from becoming unemployed.

Last but not least, crude oil price action remains troubling. Despite a historic OPEC+ deal and record supply cuts agreed to earlier this week, crude oil is trading at 18-year lows after crashing another 30% since its April 09 intraday high. This is likely explained by commodity traders anticipating crude oil demand woes to persist as economic activity remains at a standstill and global GDP growth continues to nosedive. As such, while recession risk intensifies, there remains notable risk that the stock market may soon experience another sharp downturn that sends the S&P 500 Index, Dow Jones, Nasdaq and Russell 2000 for a retest of recent lows.

-- Written by Rich Dvorak, Analyst for DailyFX.com

Connect with @RichDvorakFX on Twitter for real-time market insight

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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