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Dollar and S&P 500 Strategy for the FOMC Rate Decision

Dollar and S&P 500 Strategy for the FOMC Rate Decision

2019-09-18 04:17:00
John Kicklighter, Chief Currency Strategist
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FOMC Strategy Talking Points:

  • Top event risk over the next session - and very likely for the entire week - is the FOMC rate decision due at 18:00 GMT
  • Anticipation of another 25 basis point rate cut - a follow up to July's - has dropped from virtual certainty to a 50/50 proposition
  • With a split anticipation and a more comprehensive policy meeting with the 'SEP', we discuss prioritization with Dollar and 'risk' scenarios

The FOMC rate decision is important for more than gauging the Dollar's yield advantage over counterparts or the support it offers to global speculative appetite. Join me as we discuss the outcome and market impact live starting 15 minutes before the event.

Why is This Fed Decision So Important?

It wasn't difficult to sense the pull of anticipation in the global markets this past session. With the Federal Reserve due to weigh in on US monetary policy Wednesday afternoon, there is a bright fundamental beacon to challenge speculation. The level of anticipation can be gauged against how quickly the markets would steady despite the strong charge we were dealt through the open of the trading week. It was almost as if the geopolitical tensions roused by the attacks on Saudi oil refineries and subsequent accusations of Iranian involvement didn't even occur. Of course, the impact on crude oil stands out like an enormous scar, but baselines for capital markets like the S&P 500 and Dow barely budged this past session. In fact, through mid-day US trade, the S&P 500 was holding one of its tightest two-day average range (as a percentage of spot) since December 2017. It is not that this situation has been resolved or even that officials have found a true diplomatic balance, rather the markets are simply shifting their focus to a more immediate threat.

Chart of S&P 500 and 2-Day Average Daily Range as Percentage of Spot (Daily)

Chart of S&P 500 and 2-Day Average Daily Range as Percentage of Spot

Chart Created on Tradingview Platform

Monetary policy is one of the critically-important themes that has frequently taken control of global investors' compass bearing on and off over the past few years. As the cumulative pressure of trade wars builds alongside the recognition of its detrimental impact, we find the markets have grown increasingly aware of the fragile outlook for global growth. That is a significant shift from the state of complacency that encouraged steady build-up in risk exposure for much the past decade. That comfort with increasing our collective exposure to the possibility of economic and financial struggle in the future was principally funded by the support role that global monetary policy played through this period of recovery. Rates being reduced to near-zero (or even into negative territory) and the transition into unorthodox monetary policy seemed to reduce perceived risk held by individuals while also indirectly forcing investors to increase the balance of risk in their own portfolios simply to keep pace with benchmarks like US equity indices that established unrealistic rate of returns for nearly anything other than a portfolio that depends heavily on steady and/or sudden capital gains.

Total central bank stimulus versus VIX volatility index

The Fed holds a particularly important position in the web of global monetary policy. It made the most concerted effort of any major policy group to normalize its extreme accommodation over the past three years. That has on the one hand created tension through a wider disparity in an otherwise pervasive dovish background. It also represents the greatest source of standard monetary policy ammunition to combat future crises of the major banks. Its policy decision can in other words inform speculative confidence or hopelessness across the global markets. So, while there is a certain consideration of the Dollar's appeal relative to its counterparts, traders should keep a sharp on the state of global sentiment as the event unfolds.

Global benchmark lending rates from the world's top central banks

Scenarios for 'Risk Trends' and the Dollar

For this particular event, there are multiple aspects of importance. Naturally, the market's attention will immediately direct to whether the Federal Open Market Committee (FOMC) has decided to cut the benchmark range or hold it steady at 2.00-2.25 percent. As recently as a week ago, the market was virtually certain of a cut - and a few weeks prior to that, there was a meaningful speculation that the central bank would be forced to drop rates by 50 basis points. As of Tuesday evening, Fed Fund futures leveled the outlook for a rate cut to a charged, approximate 50 percent chance. This can set the stage for a surprise whether the central bank decides to hold or cut. Beyond the call on whether to lower rates or not, the outlook for subsequent easing will be evaluated through the Summary of Economic Projections (SEP). This is where the Fed can curb speculative response but offering a cut then reinforcing the 'outlier' aspect of the effort or to hold and lower the bounds to another move in the foreseeable future. As for Fed Chairman Powell's press conference, it will be picked over by the market and very likely US President Donald Trump.

FOMC policy decision scenarios

Looking to the Dollar in particular, the Greenback has shown very little deference to the escalation in rate cut forecasts these past months, so it is very unlikely that the currency will suddenly generate a significant reaction to the outcome of this particular meeting. A 25bp cut is the more reasonable scenario to account for ahead of time, but the lack of follow through to the July cut - the first in over a decade - means we should be careful in picking our outlet for market response. I'm partial to AUDUSD, USDCAD and USDJPY is risk aversion accompanies the response. Similarly, a 'hawkish' outcome is a hold which doesn't urge more enthusiasm for return, and the market isn't tripping over itself for marginal yield advantage. As such, picking the right pair is just as important. EURUSD is perhaps one of the more overt pairings for contrast as of late, but USDJPY should risk appetite hold out would harmonize its various fundamental considerations well.

Chart of the DXY Dollar Index and Rate Cut Expectations Through Dec 2019 and Dec 2020 (Daily)

Chart of the DXY Dollar Index and Rate Cut Expectations Through Dec 2019 and Dec 2020

Chart Created on Tradingview Platform

Risk trends is another principal outlet to watch for Fed response Wednesday evening. While broad risk trends are well off the peaks of early 2018, US-based equity indices maintain a remarkable sense of enthusiasm. Given that a cut from the central bank would also likely draw a balancing outlook aimed at curbing speculation of further moves, breaking to record highs for the Dow or S&P 500 and is hard enough; but extending the climb merely through the promise of short-term support through a fading source of investor appetite looks particularly unlikely. Alternatively, disappointment finds a market sporting an abundance of (I would argue, unearned) enthusiasm and a technical pattern at the top of its range. A swing lower doesn't have to tip a full-blown reversal, which makes it even more productive.

Monetary Policy is More Than Just the Fed and Don't Forget the Other Key Themes

Though the Fed will present a powerful distraction through the next 24 hours, it is important to recognize that there is more going on in the broader market - both on a scheduled and unscheduled basis. For the former, monetary policy is facing a run of major central bank rate decisions. I am particularly interested in the Bank of Japan (BOJ) decision as it has been reported they are considering a plunge further into negative rates; the Swiss National Bank (SNB) call as their mandate is essentially to keep pace with the ECB; and the Norges Bank who similarly attempts to keep stride with their larger European counterpart. The Bank of England (BOE) has little room to maneuver with Brexit up in the air, while the Brazilian, South African and Indonesian policy updates will speak to the fading carry appeal of the emerging market currencies.

As for the less predictable themes, the fade in recession fears has been held up before it the new-favorite 10-year to 3-month Treasury yield spread could flip back into positive territory. It is worth pointing out that, historically, the spread has inverted and return to normal before previous recessions, and we haven't even made it back above zero. In surveys, Deloitte reported that US consumers are expected to increase spending 4.5 to 5.0 percent through the holiday period (November through January), to the tune of $1.1 trillion. That would be a healthy boost to the world's largest economy. On the other hand, the New York Fed's regional business leader survey showed their outlook was the worst in a decade.

As for trade wars, we are awaiting the US and Chinese deputies' meeting in Washington DC scheduled for Thursday. Both sides have made their goodwill moves and issued their language of optimism. Now it is time for material de-escalation of the economic fight. Meanwhile, global shipping solutions company FedEx reported earnings that both disappointed relative to analyst forecasts and they lowered guidance. The source of their underperformance? The company's leadership blamed trade tensions and policy uncertainty.

US Dollar vs Chinese Yuan price chart - daily

Chart Created on Tradingview Platform

Pound and Kiwi Are Your Independent Options for the Day

If you are looking to find alternative outlets that can remain above the fray of this upcoming 48 hours heavy event risk, your list would be particularly short. It is difficult to avoid the influence of the many rate decisions - and particularly the Federal Reserve. The Greenback and risk trends are a far combined reach. That said, one currency that has deviated from both considerations and has its own event risk, the New Zealand Dollar faces local 2Q GDP after the Fed announces. I would keep tabs on a pair like AUDNZD.

Chart of AUDNZD (Daily)

Australian Dollar vs New Zealand Dollar price chart - daily

Chart Created on Tradingview Platform

And, of course, there is also the Pound. The Sterling is not without fundamental influence, quite the opposite. The state of Brexit is of great importance, but there is speculative activity in the wait for resolution. Following the highest Scottish court's ruling that Prime Minister Boris Johnson's suspension of Parliament was not legal, the issue is now being taken up by the Supreme Court of the UK. A ruling could come late this week or early next week. One way or the other, the probability of a 'no deal' Brexit will be materially influenced by this evaluation. Watch the Pound and have preferred outlets for higher or lower chance exit without a deal.

Chart of EURGBP (Daily)

Euro vs British Pound price chart - daily

Chart Created on Tradingview Platform

If you want to download my Manic-Crisis calendar, you can find the updated file here.

What fundamental themes should you follow next week? How will they impact the markets at large? Sign up for our webinars to better evaluate how market developments are shaping markets. Sign up on the Webinar Calendar.

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