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Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

John Kicklighter, Chief Strategist

S&P 500, Dollar, Inflation and Earnings Talking Points:

  • After the smallest daily trading range since Christmas Eve 2019, the S&P 500 put in for a second day of extreme quiet that reflects clear anticipation
  • With markets riding out high profile event risk like US consumer sentiment and key earnings, it is clear the Federal Reserve course is drawing the market’s focus
  • US indices and the Dollar are likely to find a break short-term after the Fed makes its bearings known but follow through depends on the outcome along with earnings and Biden updates

Attention Turns Fully Towards This Week’s Top Event Risk

The market extended its retrenchment into ever more extraordinary levels of inactivity through this past trading session. While a benchmark like the S&P 500 hovering at record highs would seem motivation for speculative bulls, it is more likely playing an encumbrance to follow through. The post-Pandemic discount has been more than worked off even with the additional amplitude from stimulus. Add to that the seasonal flag in volume and volatility, and the confluence of inactivity becomes one of the principal features of the landscape. That said, the tipping point may be just ahead. Like the calm that precedes a storm, we have seen the quiet in market trading drop to extreme levels with a two-day ATR on the same index hitting measures comparable to Christmas Eve 2019. This additional exaggeration seems to be in observation of the impending Federal Reserve rate decision Wednesday afternoon in the US session (18:00 GMT). Whether the group keeps the taps wide open or hints at an inevitable need to taper, the fog of anticipation will lift and markets can move and respond to key fundamental developments.

Chart of S&P 500 with 100-Day Mov Avg and 10-Day ATR and Historical Range (Daily)

Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

Chart Created on Tradingview Platform

While my – and I presume many other traders’ – attention is fixed on the monetary policy event later in the upcoming trading day, we will have plenty of scheduled event risk that may attempt to stir volatility through other channels. While there may be some isolated volatility, it seems highly improbable that markets would gain any serious head of steam before the Fed has its say. While there are a few different avenues of fundamental charge ahead, earnings seems to be the most thorough attempt at a distraction. Afterhours Tuesday, the highest profile corporate reports seemed to meaningfully best expectations. Advanced Micro Devices reported an earnings per share (EPS) of $0.52 against $0.44 expected and Microsoft beat with $1.95 versus $1.76. The heavy-hitter was Google which reported record earnings with a $26.29 per share figure along with an announcement of a $50 billion share buyback. Is that enough to urge the Nasdaq 100 in morning trade? Will Boeing and Discovery (Archegos victim) before-open listings further the cause? I’m doubtful.

Calendar of Key Macro Economic Events

Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

Created by John Kicklighter

The Main Event: The FOMC Rate Decision

The event that has taken all the wind out of the market’s sails is a Fed rate decision which is almost certainly going to end in no change to the mix of monetary policy the group has maintained since the fallout of the pandemic. The benchmark rate is likely to be left at a range between 0.00 and 0.25 percent while monthly purchases of $80 billion in Treasuries and $40 billion in agency mortgage-backed securities is liable to stay the course. However, trouble is starting to grow more obvious to market participants and policymakers alike. Sentiment and the presumption of growth have grown dependent on the assumption of a steadily growing stimulus. That has built in moral hazard and encouraged dangerous levels of leverage throughout the system. What’s more, economic normalcy is starting to lead into inflation risks. Moderation is inevitable, but it is the Fed’s task to make that fact palatable for those that have to take the risk back onto their own shoulders.

Table of FOMC Monetary Policy Scenarios

Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

Chart Created by John Kicklighter

Long before we get to a Fed rate hike, the authority will have to first signal to the market that it is turning the boat around. There is historical precedence for what kind of timeline we could be working with in this situation. Before the central bank was knocked off course, it began a course of tightening starting with the December 2015 hike of 25 basis points – the first increase in nine-and-a-half years at that point. However, before they tightened the reins there, they hard started to reduce their balance. That was further preceded by the reduction in monthly asset purchases which simply decelerated the built up. And, prior to that, then-Fed Chair Ben Bernanke had to signal to the world that normalizing was ahead to allay any shock. From references in April 2013 to the first hike in December 2015, this was a two-and-a-half year timeline. Even if the Fed abides by its own generous forecasts, that would make the first warnings imminent over the next few meetings.

Graph of Relative Monetary Policy for Major Central Banks

Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

Graph Created by John Kicklighter

To make things even more complicated, there is very good reason to believe that the Federal Reserve will not be able to ‘mosey’ into a low-pressure policy runway. At present, inflation pressures are rising notably. We have been tracking the rise in inflation expectations through surveys and breakeven inflation gauges. Factory-level price pressure measures have similarly registered growing pressure that many have conveniently theorized would not be passed on to the consumer – the point at which the Fed acts. That view is changing, however, with this earnings season where a number of companies have remarked that they will soon have to pass on rising costs to the consumers. If the Fed takes this seriously, the pressure could be serious.

US 5-Year and 10-Year Breakeven Inflation Rates (Weekly)

Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

Chart Created on St. Louis Federal Reserve Economic Database

The Dollar and Pairs to Watch

While risk trends are certainly at-risk from the upcoming Fed decision, the US Dollar likely carries a more concentrated exposure. The Greenback has been in retreat this past month with notable correlation to measures of relative monetary policy forecasting – which may also hold correlation to general risk trends for the currency’s safe haven status. While the implied rates through Fed Funds futures and the US 10-Year Treasury yield have pulled back, their intensity is far more reserve than that of the currency. Does that cut both ways?

Chart of DXY Dollar Overlaid with Implied Fed Rates (Daily)

Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

Chart Created on Tradingview Platform

For a Dollar pairing with a particular stake in the outcome of the Fed’s views, EURUSD is particularly interesting. Looking back to the last time the Fed started its path of normalizing while the ECB lingered, the pair dropped from 1.4000 to approximately 1.0500 from May 2014 to March 2015. I don’t expect a move of that magnitude again, but for now, the range is very tight between 1.2125 and 1.2050. That’s a good place to start.

Chart of EURUSD with 20 and 100-Day Moving Average (Daily)

Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

Chart Created on Tradingview Platform

Another cross of particularly interest for me is USDJPY. There is a risk sensitive and a relative yield matter. Should the Fed keep the taps wide open, it would theoretically boost risk appetite and thereby carry trades but it would also undermine the Greenback. The same loose theorizing with a hawkish tone could benefit the Dollar but potentially reel risk trends. This is going to be an interesting measure to watch.

Chart of USDJPY with 20 and 100-Day Moving Average (Daily)

Dollar and S&P 500 Await Fed Decision with Earnings and Biden to Back It Up

Chart Created on Tradingview Platform

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

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